Kennametal Inc (KMT) 2014 Q3 法說會逐字稿

Good morning, and welcome, everyone, to Kennametal's third quarter fiscal year2014 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)

Please note, this event is being recorded.

It is my pleasure to turn the call over to Quynh McGuire, Director of Investor Relations.

Thank you, Denise.

Welcome, everyone.

Thank you for joining us to review Kennametal's third quarter fiscal 2014 results.

We issued our quarterly earnings press release earlier today.

You may access this announcement via our website, at www.Kennametal.com.

Consistent with our practice in prior quarterly conference calls, we've invited various members of the media to listen to this call.

It is also being broadcast live on our website, and a recording of this call will be available on our site for replay through June 2, 2014.

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

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

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

After the remarks, we'll be happy to answer your questions.

At this time, I'd like to direct your attention to our forward-looking disclosure statement.

The discussion we'll have today contains comments that may constitute forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995.

Such forward-looking statements involve a number of assumptions, risks, and uncertainties that could cause the Company's actual results, performance, or achievements to differ materially from those expressed in, or implied by, such forward-looking statements.

Additional information regarding these risk factors and uncertainties is detailed in Kennametal's filings with the Securities and Exchange Commission.

In addition, Kennametal has provided the SEC with a Form 8-K, a copy of which is currently available on our website.

This enables us to discuss non-GAAP financial measures during this call in accordance with SEC Regulation G. This 8-K presents GAAP financial measures that we believe are most directly comparable to those non-GAAP financial measures, and it provides a reconciliation of those measures, as well.

I'll now turn the call over to Carlos.

Thank you, Quynh.

Hello, everyone.

Thanks for joining us today.

I'm pleased to report that we delivered on our commitment in the March 2014 quarter.

Although extreme weather conditions in North America hindered our top line growth to some extent, we delivered solid financial performance.

As always, we will stay focused on further improving margins and cash flows.

During the recent quarter, we achieved higher volumes in both direct and distribution channels, in sectors such as Transportation and General Engineering.

Sequentially, March quarter sales showed 5% organic growth from the December quarter, in line with our typical season patterns.

Our Industrial segment reported total sales were up 13% year-over-year, with 5% organic growth in the March quarter.

Generally, our Industrial business has a high correlation with the rate of global industrial production.

For this quarter, IHS Global has estimated global IPI up 3.5%.

In a slow to recover economy, where we're still early in the cycle, our Industrial segment performed that mix by about 1.5 times.

We expect to further increase that ratio as demand cycle continues to expand.

Furthermore, when IHS adjusts the estimates to the weighted average that specifically reflects Kennametal's market mix, it shows a relatively flat rate for growth from prior year.

That accounts for mix conditions in our Infrastructure segment, with additional weaknesses in Underground Mining but better conditions in Energy and Road Construction markets.

Even this environment is encouraging that March quarter total sales increased 15% from prior year, with organic growth of 3% on a consolidated basis.

This suggests that Kennametal remains in a position to outperform IPI by 2 to 3 times over the economic cycle.

Kennametal's solid results during the quarter show the resumption of growth in certain end markets, as well as the realization of greater cost efficiencies.

This underscores our ongoing focus to maximize profitability, earnings and cash flows.

It also highlights our commitment to maintain our through-the-cycle margin levels.

Also, we are on track with the integration of TMB, our Tungsten Materials Business.

We have started to consolidate and combine the best of both businesses, and to right-size facilities and headcount.

To date, the restructuring program included the announcement of two facility closures, one in Lyndonville, Vermont and the other in Gland, Switzerland.

Those operations will be consolidated into other locations in the US and Europe.

While those actions are necessary, we understand the effect that will have on our employees and we are committed to providing the necessary resources for a successful transition.

As a result of those previously announced integration initiatives, we expect to achieve considerable synergies.

We are streamlining our cost structure and driving higher productivity, as well as identifying future growth opportunities.

Those actions are concurrent with ongoing efforts to align our manufacturing and supply chain logistics within growth regions of the US, as well as abroad.

Specifically, we continue to refine our footprint to accommodate geographic shifts in customer demands.

Going forward, we expect to see continued demand growth in our served industrial end markets and across distribution channels.

Although not immediate, we anticipate improvements in markets related to our Infrastructure segment, as well.

Meanwhile, we are reaping the benefits of our Widia brand strategy, which is gaining market share.

The strategy to diversify our market mix presents broader growth opportunities, while reducing volatility throughout the economic cycle.

Additionally, I would like to note an honor that speaks to our culture of performance throughout the Company.

The third consecutive year Kennametal is named one of the world's most ethical companies by Ethisphere Institute.

This is a leading independent organization dedicated to advancing and recognizing best practice in business ethics.

Kennametal was one of only seven manufacturers worldwide to earn the distinction.

This achievement was due to a strong commitment from our employees around the world who uphold our ethical standards, and they exemplify the values and beliefs that set us apart.

We will maintain this strong ethical culture while implementing our Company-specific strategies to further strengthen our business.

Now I'd like to give an overview of the trends we are seeing in our marketplace.

In the aerospace industry, manufacturers reported low, lowest overall deliveries for the past 18 months, as they begin to transition to the new single aisle and twin aisle programs.

This changeover has impacted production, but that effect is expected to be temporary.

Both Airbus and Boeing indicated plans to increase the single aisle production rate by 10% over the next 2 to 3 years.

Regarding the defense sector, spending has decreased and further declines are expected over the next 12 to 18 months.

As a result, there will be lower activity from government projects going forward.

In general engineering, which are typically small to medium job shops, as well as distribution customers, metal cutting activity has been trending higher.

Production of capital equipment slowed during calendar year 2013, but picked up in the last six months of the year and is projected to increase 5% in 2014 and 2015.

In the US, job shops' spending is expected to increase approximately 35% in the next 12 months, driven by re-shoring trends and higher capacity utilization.

Approximately 1/3 of that outlay is projected to be machine tools.

In the indirect channels, more distributors are introducing e-commerce platforms.

The impact of e-channel in a business-to-business capabilities is expected to grow, as customers are increasingly looking to replicate online consumer shopping experiences.

Kennametal is already addressing this need, as we recently introduced NOVO, our cloud-based solution to provide customers with various ways to optimize productivity and connect via digital channels.

Regarding the transportation market, global light vehicle production is forecasted at 87 million units for calendar year 2014, reflecting a 2.8% growth from prior-year and approximately 5% higher year-over-year for the March quarter.

Key drivers of demand include record age of installed vehicle fleet, low interest rates, and stable fuel prices.

Due to full economy and emission standards, auto makers are making investments to downsize internal combustion engines, turbocharge, and use lighter vehicle structures.

Also, alternative powertrains, such as hybrid, electric battery and fuel-cell technologies are adding to the sector growth.

In Earthworks, coal stockpiles and coal spot prices remain at historical low levels.

In the central Appalachian region, additional mines are going into idle or shutdown modes.

Similarly, coal markets overseas are experience persistent pressure, especially in Australia and China.

Mines in Australia continue to lay off workers and suspend operations.

For road construction projects, the extreme cold weather in North America has resulted in a slower start to the season.

At this point, some areas in Southern region of the US have already started road work and repairs.

The construction market has been healthy in the Asia-Pacific region.

In the energy sector, North America gas inventories finished the winter season well below the five-year average.

While the rig count has remained at relatively similar levels, production activity is growing, due to higher volumes being generated by existing wells.

Natural gas production should continue to increase over the next several quarters to replenish inventories.

Overall, the global economy remains on track for a modest growth rebound, but the view is still subdued.

It is difficult to identify the underlying strengths and weakness in the overall economy, due to extreme weather conditions in the US, as well as certain events overseas.

According to IHS Global, despite some disappointing data in recent weeks, the fundamental forces of global growth are expected to remain in place.

Our global team continues to be agile and remains ready to serve our customers.

As the macro environment improves, we expect to realize greater leverage to further grow our business.

Now I'll turn over the call to Frank, who will discuss our financial results for the quarter in a greater detail.

Frank?

Thank you, Carlos.

As with prior discussions, I'll start by making some overall comments, and then I'll review our third quarter results in more detail.

So my comments are related to non-GAAP metrics, as well.

So to start off, summarize the March quarter, we delivered solid profitability and met our expectations.

We continued integrating our acquisition of the Tungsten Material Business and implementing restructuring actions.

When taking into account acquisition growth, we achieved an all-time quarterly sales record, with sales of $755 million.

Some additional noteworthy points for the quarter.

The trend of year-over-year sales growth which began in the month of September continued during the March quarter.

As a result, we realized organic growth for the second consecutive quarter.

Organic growth was led by improving demand in our Transportation and General Engineering businesses, which tend to be early cycle.

Our Industrial segment achieved 5% organic growth in the quarter.

Turning to Infrastructure, our Mining business continues to be a challenge with weaker demand globally, while our Highway Construction business was flat, due to weather impacts.

In our Energy business, order activity has been increasing and showing signs of further growth.

We continue to generate strong operating cash flows and we delivered an adjusted earnings per share of $0.74.

Now I'll walk through the key items in the income statements.

Sales for the quarter were $755 million, compared with $655 million in the same quarter last year.

Sales increased by 15%, reflecting a 12% increase from the TMB acquisition, a 3% organic increase, and a 1% increase from more business days, partly offset by a 1% decrease from an unfavorable currency exchange.

As I mentioned earlier, the March quarter is the second consecutive quarter in which Kennametal realized organic sales growth, and we are seeing improved demand from our customers in our Industrial end markets, as well as our Energy market in the Infrastructure segment.

Turning to the sales performance by business segment, our Industrial segment sales of $400 million increased by 13% from the prior year quarter, due to an 8% growth related to the TMB acquisition, 5% organic growth, and a 1% increase due to more business days, offset by a 1% decline in FX.

Excluding TMB, sales increased 8% in the General Engineering area, 5% in Transportation, partly offset by a 3% decline in Aerospace and Defense.

Our General Engineering unit increased due to continued demand from distribution channels, and Transportation benefited from increased production in the light vehicle markets worldwide.

Aerospace and Defense sales were up against higher comparisons from government orders last year.

Sales increased in all geographies.

And on a regional basis, excluding the TMB sales, Industrial sales increased 11% in Asia, 9% and Europe, and 1% in the Americas, which were dampened by weather effects in North America.

Our Infrastructure segment sales of $356 million in the March quarter increased by 18% from the prior year.

And this was driven by a 16% growth related to the TMB acquisition, a 3% favorable impact from more business days, partly offset by a 1% decrease due to unfavorable currency exchange.

Our organic growth was flat to prior year.

Excluding TMB, sales increased 9% in Energy, partly offset by a 6% decline in Earthworks.

Energy sales continued to improve year-over-year, reflecting improved demand from oil and gas drilling activity, as well as continued gains in production, completion and process applications.

Earthworks sales decreased, due to persistently weak underground coal and surface mining markets in the US and China.

On a regional basis, Infrastructure sales grew 4% in Europe, 3% in the Americas, with weather impacts in North America, partly offset by a decrease of 9% in Asia, reflecting lower demand in the Mining sector.

Moving to our operating performance, our gross profit margin was 31.6%, which included the TMB operating results and nonrecurring charges.

Excluding the impact of these items, our adjusted gross profit margin was 33.9%, compared with 31.8% last year.

Gross margin benefited from organic sales growth, as well as a more favorable business mix.

In addition, as you may recall, we had undertaken inventory reduction efforts last year that had an unfavorable impact on the gross margin in the prior-year quarter that did not repeat in the current year.

Our operating expense increased $24 million year-over-year.

Excluding nonrecurring charges and the results of TMB, our operating expense was $10 million higher year-over-year.

This $10 million increase was driven by higher employment costs related to higher sales commissions, the annual employee merit, and higher professional fees.

I also want to note that our operating expenses, excluding any acquisition-related costs, were sequentially lower by $1.2 million compared with the December quarter.

Our operating expense as a percent of sales was 20.2%, which included TMB and was 60 basis points higher than the prior year.

We continue to be disciplined, and this additional spending in the current year reflects investments to drive productivity, as well as long-term growth.

Our operating income was $77 million.

This compares with $75 million in the same quarter last year.

Excluding nonrecurring charges and the results of TMB, our adjusted operating income was $86 million.

This increase was driven primarily by organic sales growth, business mix, partly offset by higher professional fees and employment and related cost.

Our operating margin was 10.2%, compared with an operating margin of 11.4% in the prior year.

And our adjusted operating margin was 12.7% in the current quarter.

Looking at the operating income by segments, the Industrial segment operating income was $51 million for both the current and prior periods.

If you exclude the nonrecurring charges and the results of TMB, the adjusted operating income was $58 million.

Industrial's adjusted operating margin was 15.6%, compared with 14.5% in the prior year.

The Infrastructure segment operating income was $28 million, and this compares with $26 million in the same quarter last year.

Excluding nonrecurring charges and the results of TMB, the adjusted operating income was $31 million.

And Infrastructure's adjusted operating margin was 10.2%, compared with 8.6% in the prior year.

So both businesses had double-digit performance.

Our interest expense was up $1 million year-over-year, to $9 million.

This increase was due to higher year-over-year borrowings related to acquisitions.

Our liquidity remained strong.

We had approximately $340 million outstanding on our $600 million revolver as of March 31, 2014.

And our nearest debt maturity is April of 2018.

The reported effective tax rate was 24.1%, compared with 18.5% in the prior year.

The prior year benefited from the extension of the credit for increase in research activities contained in the American Taxpayer Relief Act of 2012, which was enacted in the 2013 March quarter.

But if you exclude TMB, our effective tax rate in the quarter was 110 basis points higher than previously anticipated, due to jurisdictional mix.

This had an unfavorable impact of $0.01 per share in the March quarter.

As highlighted in the press release, our reported earnings per share were $0.64.

And some of the components included the TMB base operating income contribution of $0.04, $0.03 charge related to TMB depreciation and amortization step-up for purchase accounting, a $0.07 charge related to the inventory fair value step-up related to TMB, acquisition-related charges of $0.02, as well as restructuring and related charges of $0.02, resulting in an adjusted earnings per share of $0.74.

Briefly on cash flow, our year-to-date cash flow from operating activities was $153 million, compared with $150 million last year.

Net capital expenditures were $85 million, compared with $52 million in the prior year; and free operating cash flow year-to-date was $68 million, compared with $98 million last year.

We remain diligent in our focus on generated strong cash flows and are committed to our capital structure principles.

Our balance sheet also remained strong.

At March 31, 2014, we had $113 million in short-term debt, and total debt was approximately $1 billion.

Our cash balance was $162 million, with the majority presently residing overseas.

Our net debt was $974 million at March 31, compared with $370 million in the June quarter.

And the increase was due to primarily to the Tungsten Material Business acquisition.

And our debt-to-capital ratio at March 31 was 37%, compared with 29.2% at June 30 last year.

Now I will give you a quick update on our acquisition of the TMB deal.

Overall, as Carlos alluded to, I'd say the integration of TMB is progressing well and in line with our expectations.

The TMB integration team continues to drive critical workstreams to ensure a smooth integration.

The initial focus of the integration was on financial and human resource processes, purchase accounting and maintaining key commercial relationships.

We are now focusing on implementing our systems with a combined organizational structure and go-to-market strategies that will drive future value.

We have completed organizational assignments and expect to complete the first phase of SAP in May, this month.

These actions will enable us to focus on operational integration to achieve cost synergies and have a consistent approach to the marketplace.

The impact of the TMB ongoing operations on the March quarter earnings per share was $0.01 accretive, and that consisted of $0.04 per share of base operating income and a $0.03 charge related to depreciation and amortization step-up related to purchase accounting.

In addition, we had a nonrecurring TMB charge of $0.07 for the inventory step-up and a $0.02 acquisition-related charges that totaled $0.09 in the quarter.

The inventory step-up charge was not related to purchase accounting -- or was related to purchase accounting and is now behind us.

And I'm pleased to say that this charge will not recur in future periods.

So we're done with the inventory step-up.

Also, we previously outlined restructuring actions that we expect to complete by the end of fiscal 2016.

We have estimated pre-tax restructuring charges of approximately $40 million to $50 million for those initiatives.

During the March quarter, we incurred $3 million of restructuring charges, or $0.02 per share.

As Carlos touched on, the restructuring charge included a manufacturing facility closure in Lyndonville, Vermont.

We expect the last day of production to be on or around June 30, 2014.

In addition, we announced another closure last week which relates to administrative, manufacturing and warehouse functions located in Gland, Switzerland.

We expect the last day of production to be around August 31, 2014.

Kennametal has announced to employees and other appropriate parties that we have made the decision to close these two locations.

In both cases, we are transitioning operations to other Kennametal facilities in their respective regions.

As previously stated, we expect to generate annual savings of approximately $35 million to $45 million once these initiatives are fully implemented.

And as a reminder, the initiatives consist of concentrating our footprint by consolidating operations and driving productivity improvements with our standard processes, reducing administrative overhead, and leveraging our global supply chain, including raw material costs, procurement and streamlined manufacturing and distribution.

At this time, I'd like to walk you through our total Company outlook, which includes TMB components that are part of our ongoing enterprise.

We now expect fiscal 2014 total sales growth in the range of 10% to 11%.

TMB is estimated contribute 7% to 8% sales growth.

And our organic sales growth is projected to range from 2% to 3%.

Previously we had forecast total sales ranging from 12% to 13%, with organic ranging from 2% to 4%.

And related to TMB, we still expect sales to be in the range of $200 million to $220 million, as we've previously communicated.

With one quarter remaining in fiscal 2014, we are tightening our EPS guidance to a range of $2.60 to $2.70, excluding TMB.

Again, these ranges exclude the impact of the TMB acquisition-related items.

So our current EPS guidance for TMB, as laid out in the press release, is: TMB base operation contribution of $0.10 to $0.15, which has not changed; the impact of recurring depreciation and amortization step-up of $0.07 to $0.09, resulting in the TMB ongoing operations being accretive $0.03 to $0.06 for fiscal year 2014.

As previously noted, the EPS outlook for Kennametal's stand-alone business is expected to be in the range of $2.60 to $2.70 per share.

And this is based on a higher projected tax rate of approximately 25% in the fiscal quarter.

It was previously in the lower range at the last call.

And as a result, the ongoing operations of both Kennametal and TMB are projected to be in the range of $2.63 to $2.76 for fiscal 2014.

In addition, the nonrecurring charges, as outlined in the press release, for the year include TMB inventory purchase accounting of $0.14, acquisition-related charges of $0.03 to $0.06, restructuring and related charges of $0.10 to $0.15, and tax repatriation expense of $0.09, resulting in total nonrecurring charges of $0.36 to $0.44 for the full fiscal 2014 period.

We continue to expect to generate cash flow from operations ranging from $280 million to $310 million.

And based on anticipated capital expenditures of between $130 million to $140 million, we expect to generate between $150 million and $170 million of free operating cash flow for the fiscal year.

We will continue to manage our business for the factors we can control, to deal with the near-term market headwinds, as needed.

We are focused on protecting our profitability, as well as maximizing our cash flows, as well as returns.

In addition, we will remain focused on many growth opportunities and the consistent execution of our strategies.

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

Thank you, Frank.

Moving ahead, we are committed to our long-standing mission of delivering productivity to customers.

We will continue to execute our Company-specific strategies to maintain our global leadership position.

We will strive to double revenues, while remaining focused on profitability, earnings and cash flows.

In addition, we will fully integrate the Tungsten Materials Business to gain market share, streamline our cost structure and capture savings.

We'll continue to balance our Company in terms of business mix and served end markets.

Additionally, are making progress on our goal of generating revenues equally from North America, Western Europe, and the rest of the world markets.

We will continue to execute our strategies to further strengthen our business.

In summary, we are confident that Kennametal is well-positioned.

We see new growth opportunities in terms of our diversified mix of end markets and significant emerging market opportunities.

We have a strong financial profile, cash generation capabilities, cost disciplines, and capital allocation principles.

We have a commitment to solid operational standards and a proven track record.

Thank you for your continued support.

We will now take questions.

Thank you.

(Operator Instructions)

Adam Uhlman, Cleveland Research.

Hello, guys.

Good morning.

I was wondering if we could start with a clarification on the TMB expense for the year, total of $0.36 to $0.44 for the year.

I think last time, it was $0.32 to $0.36.

But the base operations and the restructuring charges are the same.

So maybe what's changed there?

What did I miss?

Nothing.

We're trying to accelerate some additional costs and some restructuring, Adam, so that we can be well-positioned as we get into FY15.

But nothing unusual at this point.

Okay.

Got you.

Could you talk to the domestic oil and gas business?

The highway business, it sounds like that could have some pent-up demand for the June quarter.

What have you been seeing in your monthly order trends with that business?

And maybe help base our expectations for those segments of the business?

Yes.

If I start with the earth cutting side of the house, the one thing I want to point out, last year when we went Q2 to Q3, actually the business was going down.

And our underground mining business, while it's not where we were at and we're dealing with these headwinds, has increased from Q2 versus Q1, Q3 versus Q2.

So we are seeing a sequential improvement.

That's why we made some stabilization, albeit there are going to be some potential mine closures here.

So we like the trajectory there.

The construction business, you're right, was a little bit flatter.

And we think that is due to some pent-up demand or the weather-related impacts getting off to a slow start.

I don't know if we'll catch all that up in the quarter.

It may slip into next year.

But we'll watch the progress, as it relates to that.

If you think about the Energy side for our house, Stellite had a good month -- a good quarter, I should say.

So a little bit of a pick-up on some of the Energy-related businesses.

And then our core oil and gas, which has drilling, flow, analysis and some of the anvils that we make, also had a good quarter and up about the same as it was the last quarter, maybe a little bit better, if you factor a couple of these things in.

So the trajectory is moving where we had anticipated.

But supports our current guidance.

Yes, it's in line there.

Okay.

Thank you.

Thank you, Adam.

Julian Mitchell, Credit Suisse.

Hi.

Thanks.

So I just wanted to get some clarity on the OpEx trends.

You said they were up, I think, around $11 million year-on-year underlying in Q2.

They're up about $10 million in Q3.

Is that a good run rate for several quarters, looking ahead now?

Or is there something exceptional going on in this fiscal year?

No.

I don't think there's anything exceptional.

As we talked at the beginning, last July we said we were going to make some additions relative to some sales force addition.

We've incurred expenses related to the NOVO project.

So they're obviously being amortized as we go through.

So this quarter, we came in at 20.4%, and we said, hey, we'll be at least 21%.

I think we've corrected the first half, was like 21.5%, if you look at the first half.

So we'll get back down to 21%, so we have a little bit more control in the second half, as we go into the next fiscal year.

But nothing unusual, Julian, as it relates to one-timers, plus or minus.

And then we'll see what we do with some additional restructuring going forward.

Thanks.

And then within the Industrial business, General Engineering has had a couple of good quarters in a row of year-on-year organic growth.

Carlos, your comments at the beginning sounded pretty upbeat on that.

I guess you're saying that even as comps get tougher, that business can still hang onto that kind of growth rate?

Yes.

I think that they've had good growth last quarter and this quarter that was just standard.

And then as we look to some of our peers that are in the same group, like MSC and some of the other customers of ours, it's very consistent.

And I think that we haven't seen any restocking whatsoever in that channel.

So we feel cautiously optimistic.

It's just a timing issue.

Julian, I'd add to that.

General Engineering, there's a lot of indirect that goes through there.

So we were actually -- their indirect channel was up 9% in the quarter.

So that kind of goes pretty much hand in glove there.

And the reason we say that there isn't really been any restocking is been at the level last quarter was 10%.

This quarter is 9%.

So it really shows you that it's staying very close to demand.

So as the macro improves, we're going to see that accelerate.

Again, the question is the timing.

Thanks.

And very quickly, Frank, just one follow-up for you.

Operating cash flow, I think it was, about $150 million year to date.

You're guiding for $295 million or whatever at the midpoint for the year.

So a big swing in Q4.

Maybe just a little bit of color on that?

Yes.

And if you go back historically, you get the Q's and the K's and you back out, our fourth quarter's typically our strongest quarter by far.

Last year alone, we did well in excess of over $100 million in free operating cash flow.

Now what will drive it there, by tightening working capital.

We typically end the quarter, March, with a high sales period.

So we'll collect a lot of receivables there.

So we typically have strong collections, as well as managing our inventory.

So you'll see some working capital.

And then the fourth quarter's typically our highest earnings period.

And then we'll obviously keep a close eye on CapEx.

So we feel that we're going to be, based upon history, we should be right in that sweet spot.

Great.

Thank you.

Thank you, Julian.

Eli Lustgarten, Longbow Securities.

Good morning, everyone.

Can we talk a little bit about the Industrial results by end market, both globally and subset?

I guess North America being up 1%.

Can you give us -- I assume that was significantly affected by January, February.

Maybe you can give some trends through the quarter, what difference March was.

Aerospace was down, which probably was a little bit of a surprise, even though it's a tough comp.

What happens there in the fourth quarter and as you look out?

And give us some color as to what's going on, what you'd expect?

Particularly, General Engineering did well, but the Machine Tool Show is in September, that always stretches things out.

Can you give some sense of what's going on there?

In Aerospace, Eli, we have a good portion of Aerospace as Defense.

And as Frank said in his commentary, we did have a strong shipment a year ago for Defense, in this case.

And the overall switch by Boeing and Airbus from the old models to the new models, when you look at the numbers, the output is slightly lower.

But we think that's temporary, at least from the commercial side of the house.

The Defense is going to continue to be challenging.

It's really hard for us to quantify the weather-related issues in North America.

But certainly, there is some impact in there.

And I think that that's, again, a timing issue.

We're going to start seeing North Americas starting to come back and deliver higher growth.

Did you see any big change in March versus January and February?

Have you looked at any of the monthly patterns?

Or was it just, it's slowly getting better as you go through it?

Yes.

January was clearly the low point.

And I'm just talking Industrial, to your question.

February was better, and March was slightly better.

So not a big snap back yet.

Well, from January to February, yes, it was a little bit of a pick-up, compared -- if I look at March versus January, March did end up on a decent number for the tooling side.

The most impressive thing is the adjusted profitability with Industrial.

You got to the mid-teens.

I assume we're assuming that's sustainable and probably improve in the fourth quarter, as we go through it?

Can you give us some idea of what's behind that?

Is that just mix?

It's primarily volume.

As we always talked about the fact that we have a fixed capacity, because we waiting for the growth, which in a way has penalized us last year and the beginning of this year, is going to reward us going forward.

So the volume drove it up, so we expect it to get a little bit better?

Yes.

As we've seen in the past.

Our incremental EBIT margins are in line with our historical capabilities, yes.

And can you talk about, when we go to Infrastructure, we got back to a low double-digit margin.

Are we sort of stuck in that area until we get some clarity and better mining and highway expenditures and stuff like that?

Are we stuck in the low double digits?

Is that where we'll be in Infrastructure for a while?

I would say that's the safe play there, Eli.

Energy, obviously, is on the plus side.

And then with some of the IGT stuff on Stellite, they're obviously spotty, some of the orders.

There's some bigger stuff there.

But I think we need a little bit of a pick up there, because the Mining's a little bit better for us, profitability-wise, than highway construction.

So I expect we'll be up, but the mix may not be as good as the past.

But nothing significant.

But I expect it to improve sequentially.

Again, the volume is going to help us there.

Ross Gilardi, Bank of America.

Mr. Gilardi, your line is open.

Andy Casey, Wells Fargo Securities.

Good morning, everyone.

A follow-up question on Eli's, just two-fold.

First, the Infrastructure business, if I look at the core ex-TMB, very good margin improvement year-over-year, 160 basis points with substantial incrementals.

Is it fair to say mix was the biggest driver, or what else should I consider?

Yes, mix and volume.

Volume in a couple areas, because there's really four sub sectors in there that we're not going to get into.

But that's primarily the volume.

Okay.

Thank you.

And then similar to another question Eli asked about the Industrial, could you run through the trends that you saw within Infrastructure, January, February, March?

Again, I thought I gave that to Eli.

But in January --

Infrastructure.

He's asking about the Infrastructure.

Andy, Infrastructure or Industrial?

Infrastructure, please.

Okay, Infrastructure.

Similar pattern.

January, that was a down month.

And I think you guys felt that when we did the rolling three months.

So that was pretty much a negative, a slight negative in January, and both were positive in total the following two months.

So pretty much a similar type of improvement, February, as well as March.

Okay.

And then at one point, I think we were waiting for drilling activity to pick up.

It seems like that occurred.

Did you see that during the quarter?

Yes.

Okay.

Thank you very much.

Thank you, Andy.

Walter Liptak, Global Hunter.

Thanks.

Good morning, guys.

Wanted to ask a follow-on to the Energy question.

Have you said yet what the growth rate was for your Energy businesses?

Just what's in the press release.

Okay.

I'm sorry.

What was the growth rate?

Was it mid-single digits, double digits?

Yes, we said Infrastructure increased 9% in Energy.

And that's excluding TMB.

Got it.

Okay.

And does this business have better operating leverage than other businesses?

I think this is a stand-alone operation, right?

You've got to bifurcate it.

I would say that the core drilling stuff is a little bit higher, and then the IGT stuff is a little bit less.

But we've been doing some cost moves to try to get the IGT up to where it is.

So right now, it's a little bit of a different, on the Kennametal base business being a little bit higher than the acquired Stellite, when we talked about when we made the acquisition to try to move that up towards the Kennametal level.

Okay.

Got it.

And on the TMB acquisition, was the revenue where you were expecting it for the quarter?

Is the revenue trend where you'd like to see it?

I think it performed very similar to Kennametal.

I tell people, I think about TMB as almost like a mini Kennametal, where the tooling side, the Industrial, was better than the Infrastructure-related business.

But we have factored that in.

This is very consistent what we had anticipated back in November when we provided our guidance at $200 million to $220 million.

So we're pretty much in line there.

Now they would also have some weather effects that impacted their business, because probably a little bit more pronounced.

Because as we pointed out, 75% of their business is in North America or the US.

So there would have been a little bit of a -- probably of a bigger impact on them on a standalone.

But pretty much in line.

Okay.

Got it.

So when we look at the fourth quarter, they have a big fourth quarter, as well, too, right?

Yes.

They behave very similar to how we do.

Okay.

And when you made this acquisition, we were looking at double-digit operating margins.

Would you expect to get there on your full-year basis?

I would think it would be close.

You can see all of the charges that are in there.

If you take the press release and you see the $77 million, $78 million of sales, if you exclude all the purchase accounting, the ongoing, just to give you an idea, it's at about a 9.5% pure base run rate right now, without restructuring.

So that will give you -- that's the March quarter, to give you an idea where we think this business is going to go.

Right.

Exactly.

And so for the full-year, we would be double digit, 10%, 11%?

It's going to be tough.

We'll see how it shakes out here.

Remember, we acquired this officially November 4. We had the two weakest months of the year, particularly with the November, with Thanksgiving and then the Christmas period there.

So we'll see.

Okay.

Great.

Thank you.

Ross Gilardi, Bank of America Merrill Lynch.

Thanks very much, guys.

Can you hear me now?

Sorry about that earlier.

On Allegheny, I'm just wondering, can you comment a little bit more on customer reception to Allegheny now under the Kennametal banner, and what the feedback has generally been?

Actually, it's been very positive.

First of all, all the signable contracts, 100% of them, were assigned to Kennametal, so 100%.

Second of all, it's been very positive.

As a matter of fact, in the long-term, I think there's some good sales synergies that will come as a result of the acquisition, because the customers are excited about having that business be part of Kennametal.

So the customers are excited, and we are excited about the business.

And our people, the TMB people, are very excited to be part of Kennametal, as well.

Can you talk a little bit more about Allegheny's inventory position?

You had explained last quarter that there was more inventory than you anticipated.

Have you had to adjust production to deal with that?

Or is the inventory position now more in line with where you want it to be?

We didn't have to do anything.

It was just there is more inventory when we acquired it that was assignable at day one.

And a lot of stuff, as you remember with the strategy, they have a lot of recycling.

So this is raw material, scrap.

And this the type of stuff that doesn't go bad that will feed into both our customers, once we run it through the recycling, as well as used for internal consumption.

So it's not like there's a lot of finished goods inventory laying around.

So no issues whatsoever on that point.

All we did is, our charge to goodwill was less by the amount that we increased the inventory.

So I think that's good news.

We can get money for the inventory.

We're not going to be able to get money for goodwill.

And then just lastly, guys.

On your balance sheet, can you maybe give a little bit more color on where you want your debt levels to be before you might shift your prioritization back more towards returning to holders, and how far away you think that we are from that?

Again, our overarching theme is we want to be an investment-grade rated company.

We stay true to our priority uses of capital.

Our goal immediate is to obviously pay down debt.

That's the main focus.

Obviously, from where we finished the quarter, we want to -- we finished at 37%.

We want that to come down.

We've always said we'd be comfortable that 355 to 45%, with the right acquisition, and then we'd work it back down.

And then once we get to a level that we're comfortable with, then we'd look at the standard stuff.

And the only other thing that would be unique would be share buyback, which we typically do to offset dilution.

So it remains debt pay down, CapEx into the business, putting it in so we can accelerate the synergies across the organization, improve our customer fill rates.

And then secondarily, it'll be the dividend increases and buybacks, at this time.

But on average, we like to be between 30% and 35%.

That's the comfort zone for us.

And we're going to be at times a little higher than that, at times we'll be lower than that.

But overall, that's kind of where we look to be at.

Great.

Thanks very much.

Joel Tiss, BMO.

Hello.

Last and least.

How's it going?

We always save the best for last, right?

Yes, whatever.

(Laughter)

Can you talk -- you haven't talked at all about pricing and the markets.

I'm sure there's probably nothing going on.

And then just on TMB, is that -- if we think longer term over the next 3 to 5 years, is that a structurally lower margin or higher margin business than overall Kennametal?

The first one on pricing.

Pricing -- a little pricing, effective January, we put in for Industrial.

Nothing really on the Infrastructure side.

And I think a lot of the competitors probably did the same thing in January.

So that's the first one.

And then structurally, when you really think about this base business, Joel, and when we rationalize a number of these facilities, I think this is above the Kennametal average longer term, my view.

So I think this is accretive to the overall Kennametal portfolio.

Okay.

Great.

Thank you.

Thank you, Joel.

And ladies and gentlemen, this will conclude the question-and-answer session.

I would like to turn the conference back over to Quynh McGuire for her closing remarks.

This concludes our discussion today.

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