Kennametal Inc (KMT) 0 Q0 法說會逐字稿

Good morning.

My name is Regina, and I will be your conference operator today.

At this time I would like to welcome everyone to Kennametal's fourth quarter fiscal year 2012 earnings call.

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

After the speakers' remarks there will be a question and answer session.

(Operator Instructions).

I would now like to turn the call over Quynh McGuire, Director of Investor Relations.

Please go ahead.

Thank you Regina.

Welcome everyone.

Thank you for joining us to review Kennametal's fourth quarter and fiscal year 2012 results.

We issued our quarterly earnings press release earlier today.

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

Consistent with our practice in prior quarterly conference calls, we have invited various members of the media to listen 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 August 27, 2012.

I am 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, Marti Bailey.

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

After the remarks we will be happy to answer your questions.

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

The discussion we will 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 are 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. The 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 to hear about Kennametal's fourth quarter and fiscal year 2012 results.

I am pleased to report that in fiscal 2012 Kennametal again made excellent progress in further implementing our strategies.

We outperformed our markets, and set new performance records.

We established clear goals, realized further improvements in operational efficiencies, while successfully managing multiple headwinds.

As a result we more than delivered on our financial targets, exceeding 15% EBIT margin, and 15% return on invested capital.

We achieved those measures a full year earlier than planned.

This performance represents the second year of all-time records for profitability and return levels.

For fiscal 2012 global industrial production increased by 2.9%, demonstrating that a number of end markets continue to grow.

Yet by comparison Kennametal realized 9% organic sales growth over the prior year, clearly outperforming the industrial markets.

In addition, our Company-specific initiatives such as geographic expansion, new product development, and complementary acquisitions, continue to position Kennametal to achieve significant margin and earnings expansion.

In particular, I want to thank Kennametal employees worldwide for their dedication and engagement at all levels to drive the performance of our Company.

Our team demonstrated their commitment to continuing to deliver value to our customers, shareholders, and colleagues around the world.

We have made outstanding progress on priorities that contributed positively to our results.

This includes improved safety and productivity, as well as utilizing standardized SAP to streamline our processes and maximize efficiencies.

Thanks to those efforts, and staffs taking over the past several years to restructure and reduce our costs, we realized $170 million in permanent savings on an annualized basis.

We continue to be diligent about cost reduction actions.

As always, we are actively pursuing measures to continue to improve our operating excellence and further strengthen our foundation.

We finished the year on a positive note as well, posting our 10th consecutive quarter of organic sales growth.

This reflects the successful execution of our strategies, across a balanced and diverse mix of served end markets and geographies.

We further increased sales and strengthened our business portfolio with the recent satellite acquisition.

During the June quarter we did see some moderation in demands.

However, the manufacturing sector continued to outgrow the overall economy.

We realized ongoing growth in industrial markets, such as transportation, and later cycle aerospace.

For the industrial segment on a regional basis, both Europe and the Americas reported year-over-year sales growth, while Asia declined versus a stronger comparison to prior year.

For infrastructure markets, sales were flat overall despite lower production activity in North America, due to the relatively high storage levels in mining and energy.

We viewed those as near term challenges and expect to see growth return in the next one to two quarters.

Regionally for our infrastructure segment sales, were lower in the Americas but were strong in Asia and modestly positive in Europe.

Keep in mind that Kennametal's diverse mix of served end markets and geographies should help reduced volatility across economic cycles, as demonstrated by this year's results.

In terms of geographic diversity, Kennametal sales were 46% from North America, 28% from Western Europe, and 26% from the rest of the world markets for this year.

Another way we improved our sales mix is through our channel strategy for the Widia Brand.

Which continues to perform well and gain market share.

Widia is positioned as a premium brand in its addressable markets.

The fiscal 2012 Widia brand sales grew 12 about percent over prior year reflecting the success of the strategy.

Further, we continue to focus on developing new products for both the Kennametal and the Widia brands, which continues to perform well and gain market share.

Widia is positioned as a premium brand in its addressable markets, for fiscal 2012 Widia brand sales grew 12% over prior year, reflecting the success of this strategy.

Further, we continue to focus on developing new products for both the Kennametal and the Widia brands.

These supports are again a growth strategy, while also maintains the market leadership position of our brands.

We generated 31% of sales from new products in fiscal 2012.

Innovation enhances our value in the marketplace, and as our strong margin performance reflects, we maintain pricing discipline to recover raw material cost inflation.

Especially costs related to tungsten.

I would like now to share our perspective on end market trends that drive our outlook for the year ahead.

In aerospace, the recent Farnborough International Air Show in London was reported to generate orders for 800 new aircraft, totaling approximately $72 billion, which represents a substantial increase from the same event two years ago.

Aircraft manufacturers now have a significant production backlog.

For example, AirBus plans to establish a fourth A320 plant in the US, while Boeing is expected to increase production by 30% to accelerate aircraft deliveries and reduce its backlog.

In transportation, the continued production increases are expected in North America, and suppliers remain relatively optimistic.

In Europe, economic uncertainty appears to be dampening demand, suggesting further decline in auto production rates.

However, the premium European car makers where Kennametal has stronger presence, are expected to hold production steady for the remainder of calendar year 2012.

In China, vehicle production is expected to increase modestly in the near term.

In the general engineering markets, the outlook for production of machinery and equipment remains favorable.

In the US, customers are cautious due to concerns about tax policy, healthcare, the election, and regulatory climates.

We expect US exports of machinery to show continued growth in 2012, but at a slower pace.

While Europe is expected to weaken significantly.

In metal work and machinery, manufacturers are benefiting from increased production of autos and commercial aircraft, partially offset by slowing in Europe and key emerging markets.

In the underground mining, the Energy Information Administration reports that year-to-date US coal production is 6% lower than prior year.

It is predicting year-over-year declines of 9% for calendar 2012, and 4% for calendar year 2013.

Although coal share of the US electric power generation has been declining, it is expected to grow modestly in calendar year 2013, with the likelihood of higher natural gas prices.

In China, the coal market has slowed while increased exports in South Africa are expected to bring growth to the industry.

In the road construction, the new two year $105 billion US federal highway bill that was recently passed should be favorable to the industry longer term.

Due to the lead time required state by state for upfront project work at various transportation departments, this legislation will likely take until calendar year 2013 to benefit highway rehabilitation activities.

In Europe, the construction outlook depends on the outcome of the debt crisis.

However, Germany is expected to remain stable for the near term.

In the energy market, the rig count in the Americas increased 5% year-over-year.

As increased oil drilling makes up for the decline in the development of gas wells.

With the decline and unseasonably warm weather for six months to date in 2012, storage levels for natural gas have decreased, and are closer to a five year average.

On a long-term basis, natural gas infrastructure has continued to build, and is viewed as the power supply for the next century.

In developing countries with increased middle classes energy continues to grow.

Behind those market factors Kennametal's global team will continue to execute our strategies.

We deliver historically high levels of profitability and earnings by exceeding our target of 15% EBIT margin, and 15% return on invested capital in fiscal year 2012, one year ahead of schedule.

There is an additional upside to our investment story and we continue to focus on growing our business.

At this time, I would like to make another comment on Kennametal's record financial performance.

Results like these are due to sound planning and successful execution.

One of the key reasons can be attributed to our excellent and strategic planning.

During the June quarter, Kennametal was honored by the Association of Strategic Planning with Richard Goodman's Strategic Planning Award.

This recognition is awarded to those organizations that demonstrate strong analytical methodologies, and sound processes in strategic planning.

It speaks to the fact that we have established an effective planning system to advance our strategies at Kennametal, helping us to continually deliver the promise to our customers, and to be a breakaway company, one that can be profitable throughout the economic cycle.

To summarize, we continue to pave the way for profitable growth.

We are diversifying our business, both organically as well as through acquisitions, such as the recent Deloro Stellite transaction.

Our guidance for fiscal year 2013 reflects organic topline growth of 5% to 7%, which is approximately 2 times the currently forecasted industrial production growth of 3.4%.

Including satellite, Kennametal expects total sales growth in the range of 7% to 10%.

We will continue to execute our strategies for value creation and expect to sustain strong performance over the diverse cycles represented in our portfolio.

I now will turn it over to Frank to go into more detail on the financials.

Thank you, Carlos.

I will start off by making some overall comments on the full fiscal year, and then I will review the fourth quarter in a little bit more detail.

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

Let me start off with fiscal 2012.

I would say that fiscal 2012 is another record performance for sales, profitability, earnings per share, and return on invested capital for Kennametal.

We more than delivered on our goal to achieve 15% EBIT and 15% return on invested capital, one year earlier than our commitment.

We also enhanced our overall financial position, liquidity and financial flexibility.

We refinanced our $300 million ten year bonds at 3.875%, and consistent with our priority uses of cash, we have reinvested into the business with $96 million of capital expenditures.

We acquired Deloro Stellite for $383 million.

We repurchased 2 million shares of stock, and we increased the annual dividend by $0.08 per share, or 14%.

This is a great year on many fronts.

Turning to the June quarter, our results were also strong, especially in light of moderating macro conditions.

Organic sales was 1%, but was notable given the slowdown in energy and mining markets, and softening macro concerns.

Our operating margin was 15.9%.

And adjusting for Stellite, our operating margin was 17.6%.

Earnings per share were $1.08 excluding integration costs and nonrecurring purchase accounting charges.

And Stellite contributed approximately $0.04 per share operationally in the quarter, and incurred approximately $0.06 of integration and nonrecurring charges for a net dilution of around $0.02 per share.

Foreign currency was a headwind in the quarter, and our foreign currency rates had an unfavorable impact of approximately $0.08 per share compared to last year.

We also paid off our 2002 bonds at maturity on June 15, and we delivered strong free operating cash flow, and we made further progress with our inventory reduction initiative, and our adjusted return on invested capital of 16.3% was a June quarter record.

Now I will walk through the key items of our income statement.

Sales for the quarter increased $45 million, or 7% to $739 million.

And this compares to $694 million in the June quarter last year.

The increase is due to organic growth of 1%.

The Stellite acquisition contributed 10%, and more business days of 1% significantly offset by foreign currencies, which had an unfavorable impact of 5%.

In the June quarter, we experienced moderating conditions and unfavorable foreign currency impacts that had a significant impact on total sales growth.

Despite the headwinds as Carlos noted, this represented the 10th consecutive quarter of year-over-year organic sales growth.

Turning to the business segment sales performance.

Our industrial segment sales of $421 million declined 4% from the prior year quarter.

This was driven by 2% organic growth, offset by 6% unfavorable foreign currency effects.

On an organic basis the increase in sales was again led by aerospace and defense growth of 14%, transportation growth of 6%, partly offset by a 4% decline in general and engineering.

Regionally our sales increased by approximately 7% in Europe, 3% in the Americas, and declined 9% in Asia, due to decelerating market conditions in China, coupled with strong comparisons from the prior year.

The infrastructure segment had sales of $318 million, and increased 24% from the prior year quarter driven in part by the Stellite acquisition which contributed 26% growth.

This was partly offset by 2% unfavorable foreign currency.

Organically, sales modestly increased in earthworks, which reflected a somewhat lower production in North America underground mining which began in April, and the highway construction business got off to a relatively slower start.

In energy, sales were slightly lower due to a decline in natural gas prices, high storage levels, and reduced drilling activity.

We believe these markets are currently at bottom and expect improvements in the beginning of calendar 2013, as commodity prices move up and the benefits from the new highway bill begin to materialize.

Regionally sales increased by approximately 11% in Asia, 3% in Europe while sales in the Americas were lower by 5%, also due to stronger comparison in the prior year.

Now a recap of our operating performance.

Our gross profit margin was 35.8%.

Our gross margin also includes a full quarter of the operating results from the Stellite acquisition, which had a dilutive impact to Kennametal's gross margin due in part to purchase accounting and related adjustments during the quarter.

Excluding Stellite, our gross margin expanded sequentially from the March quarter by 150 basis points.

More importantly, our gross margins improved sequentially as raw material consumption costs declined as anticipated, and we had a better sales mix.

Additionally, our inventory declined $21 million, principally driven by a reduction in finished goods.

And our gross margin was down year-over-year due primarily to the Stellite acquisition and lower volumes.

Operating expense declined year-over-year again.

Overall lower employment and related costs and favorable foreign currency exchange were partly offset by the acquisition and related costs.

As always, we remain very focused on controlling general and administrative costs in order to fund selective investments in selling related areas.

Our operating expense as a percent of sales was 19.2% for the quarter, down 140 basis points from the prior year of 20.6%.

Note also that Stellite's operating expense as a percent of sales are lower than Kennametal's, and overall are accretive to the percentage.

Our operating income was $117 million compared with $115 million in the same quarter last year.

Our operating income included $1 million of net acquisition related loss.

The prior year operating income included restructuring and related charges of $7 million.

Our operating income benefited as a result of higher sales volume, pricing and lower employment costs and restructuring costs, slightly offset by higher raw material costs.

Our operating margin for the June quarter was 15.9%, and as I said earlier if you adjust for the Stellite acquisition our operating margin reached 17.6%.

Looking at the business segment's operating performance the industrial segments operating income was relatively flat at $76 million compared to the same quarter of the prior year.

Industrial operating margin included $5 million of restructuring related charges last year.

Operating income benefited from higher sales volume, pricing, lower employment and restructuring costs, offset by higher raw material costs coupled with lower absorption impacts driven by the inventory reduction.

Industrial's operating more to segments operating income was $42 million and that compares with $38 million last year.

Infrastructure's operating income included $1 million of net acquisition related loss, versus $2 million in restructuring and related charges in the prior year.

Our operating income in this segment benefited from sales volume, price realization, lower unemployment and restructuring costs, also offset in part by raw material costs and acquisition related costs.

Excluding the Stellite acquisition impact infrastructure's operating margin was 17% for the June quarter, compared with an adjusted operating margin of 15.6% in the prior year quarter.

Interest expense increased in the quarter $3 million year-over-year.

I should say in the June quarter to $8.5 million due to higher debt levels attributable to the Stellite acquisition, and the February bond issuance partly offset by lower bank revolver following margins.

The $300 million June 2002 notes were paid off at maturity on June 15.

Interest expense increased $500,000 sequentially versus the March quarter due to higher debt levels attributable to the acquisition.

Effective tax rate was 20.3% and this compares to 20.8% in the prior year quarter.

And regarding our bottom line performance, we reported the June quarter diluted earnings per share of $1.06, compared with $1.04 in the prior year quarter, and the June quarter earnings per share included acquisition related dilution of $0.02, and an unfavorable impact of $0.08 due to foreign currency while the prior year earnings per share included restructuring and related charges of $0.07.

Turning to cash flow.

Our cash flow from operating activities was $290 million, compared with $231 million the prior year.

Net capital expenditures were $96 million compared to $74 million in the prior year.

Free operating cash flow for 2012 was $193 million, compared to $157 million in the prior year.

As noted earlier, we have consistently generated strong operating cash flow providing substantial liquidity and capital for growth.

We are highly disciplined in our capital allocation process, and ensure that we invest in initiatives with the highest growth potential.

We also actively managed our business portfolio.

We invested approximately $383 million in the Stellite acquisition that has strong growth opportunities, and we returned over $110 million to shareholders through share repurchases and dividends this year.

As I noted earlier we repurchased 2 million shares during the fiscal 2012 period, and increased our dividend 17% in October.

Our discipline and balanced investment approach is a key contributor to long-term returns.

Our balance sheet remains strong.

Our cash position was $116 million, and we remain focused on improving our working capital including DSO, inventory turnovers, and DPL, which were at similar levels for the June quarter compared to March.

As discussed earlier in the year, we also continue with actions to better balance our inventory levels, and as we get into fiscal 2013 we expect to make even further progress.

At June 30, our total debt was $566 million, down $75 million, or 12% from March 31 due to strong free operating cash flow.

Debt was up $253 million versus the prior year, and that is due primarily to the Stellite acquisition and the September quarter share repurchases.

During the June quarter alone, our strong free operating cash flow enabled us to pay down 20% of the Stellite acquisition debt.

And our debt to capital ratio as of June 30 was 25.3% compared to 15.9% last year.

Our US defined benefit pension plans remain 100% funded, and our adjusted return on invested capital 16.3%, up significantly from 14.8% in the prior year.

Now I will give you a quick update on Stellite.

The integration of Stellite is progressing well and it is in line with our plan.

In fiscal 2013 we will focus more tightly on aligning our functional organization, enabled by the implementation of SAP at the principal Stellite operating locations.

For the quarter Stellite's reported dilution impact on earnings per share was approximately $0.02, and this included approximately $0.06 per share of purchased accounting and integration and related charges offset by Stellite's operational contribution of approximately $0.04, demonstrating a favorable trend in operating performance.

For the year, Stellite's reported dilution impact on earnings per share was $0.09, which includes $0.13 per share of purchased accounting and integration and related charges, and Stellite contributed $0.04 operationally for the four month period year-to-date.

Now I will touch on our outlook.

In summary, our outlook for fiscal 2013 has earnings per share at the midpoint growing over 10% from the prior year.

And as Carlos noted this assumes a 5% to 7% topline organic growth.

Also we will continue to follow our priority uses of cash.

We announced that we increased our dividend by 14%, and expanded our share repurchase authorization program from 8 million shares to 12 million shares.

Our outlook for fiscal 2013 also takes into consideration a moderation in industrial activity and short term slowing related to natural gas drilling and underground coal mining in North America.

However, we expect Widia to continue to grow faster than the market.

The acquisition of Stellite's realized benefits from synergies, and our overall Company specific strategies will help us outperform global IPI.

We still believe our margin opportunity potential has room to expand long-term as the markets are expected to continue to grow, raw material prices stabilize, and our strategies drive additional opportunities.

The following are assumptions also embedded in our outlook to help you with your model.

As I said earlier we are projecting 5% to 7% organic growth which is outpacing global industrial production.

Regarding the Stellite acquisition, we expect operational earnings contribution in the range of $0.20 to $0.30 per share.

Integration costs primarily for the implementation of SAP are forecasted to be approximately $6 million, or $0.05 per share.

On a net basis we expect Stellite will contribute earnings per share in the range of $0.15 to $0.25 in fiscal 2013.

Foreign exchange is expected to be a significant headwind compared to the prior year, and will have an unfavorable impact on operations which we estimate to be $0.20 to $0.25 per share.

Interest expense is expected to average approximately $6 million a quarter.

That is down $3 million or $0.03 per share, due to the bond refinancing, so that will be a favorable pickup, and our expected tax rate is expected to be between 24% and 25% due to including a full year of Stellite's operations and an unfavorable jurisdictional mix, which we estimate to be $0.20 to $0.25 per share lower than the prior year.

Earnings are expected to be somewhat consistent with our historical seasonal patterns, with 40% of earnings in the first half and 60% in the second half of the fiscal year.

Consistent with our capital structure principles we plan to reinvest back in the business with CapEx between $115 million to $125 million for inclusion of expanding tungsten production capabilities, growth, productivity and some international expansion.

We also approved an increase to our dividend of $0.02 per quarter or 14%, and we increased our share repurchase program to 12 million shares, with 8.5 million shares available under the amended authorization.

We expect our free operating cash flow to approximate 80% to 100% of net income, and this will become an objective for going forward to move towards 100%.

Our compensation metrics have been modified to include free operating cash flow as a metric.

Based on these factors we expect earnings per share for fiscal 2013 to be in the range of $4.10 to $4.40 per share.

The midpoint of this range represents a 10% increase to fiscal 2012's adjusted earnings per share of $3.86.

At this time I would like to turn it back to Carlos for a few closing comments.

Thank you, Frank.

As demonstrated in this past year's results, we believe that we can sustain and significantly grow profitability, earnings and return levels.

We look forward to fiscal 2013, and remain committed to executing our strategies.

We continue to focus on balancing our served end markets, business mix, and geographic presence to more effectively manage risks associated with cyclicality.

We will also maintain discipline regarding our manufacturing footprint and cost structure.

Kennametal's fiscal year 2013 outlook reflects our continued expectations to outperform global industrial production to Company specific initiatives.

Our EPS guidance at the midpoint represents a 10% increase from prior year as Frank mentioned.

In addition, we expect to continue generating strong cash flows, which provide us with a stronger financial position, enhanced operating flexibility, and greater liquidity.

Most importantly we will remain disciplined in our capital allocation process, and seek to maximize shareholder value.

Our priority uses of cash will be consistently applied to acquisitions to enhance our technology platforms, reinvesting strategically in our business, repurchasing shares, and paying dividends.

As Frank said, our Board has approved expanding our buyback authorization to 12 million shares from 8 million shares, and additionally approved a 14% increase in the dividend.

Both of those actions represent our commitment to shareholders, as well as our confidence in Kennametal's strong cash generation ability going forward.

In summary, we will continue our journey of always improving our customer centric enterprise, as far as being a breakaway company, one that is profitable throughout the economic cycle.

Thank you for your interest in Kennametal.

We will now take questions.

Thank you.

(Operator Instructions).

Your first question will come from the line of Eli Lustgarten with Longbow Securities.

Good morning, everyone.

How are you doing?

Not too bad.

Nice quarter.

Thank you.

Can we talk a little bit about the guidance?

You talk about 5% to 7% organic growth.

Can you perhaps give us some insight of the components of the 5% to 7% how much is invested, how much you think is infrastructure, which markets are generating that kind of growth, because it is really a mixed bag out there.

And I assume additionally geographically some idea where it is coming from?

We will not break it down from infrastructure and industrial.

However, I can tell you that the end markets are going to expect, we expect to grow obviously are aerospace, is automotive as you saw in the capital group's market today, the automotive, transportation outpaced, carried that growth.

We continue to see that.

We expect that the energy will come back in the second half of the year, our fiscal year.

And we also think that the highway bill is going to help our business in the second half of the year.

And relative to geographies, relative to geographies, I think we will see the North American market to continue to lead, and perhaps the rest of the world is going come a little better for us, and then followed by Europe.

And again, I want to remind you that we grew 3 times IPI this year, and our plan consists of growing IPI by 2 times.

So the question is what happens if IPI is lower, we also have the fact we can grow 3 times IPI.

We think that is a pretty balanced outlook.

Fair to say that you are sort of are expecting most of the topline to come in industrial, and infrastructure will probably have a more difficult first half of 2013 and a sort of improving second half?

Is that the profile that we are looking at?

Eli, I would say that.

Particularly on the industrial side I think we expect the first half to be a little bit softer, particularly in Europe and China.

Expect a little bit of a rebound in 2013, and very similar to what Carlos said in the second half, we also expect the construction bill, the energy, and Stellite will start to come into the organic calculation when we have into the fourth quarter, and we expect a little bit of an opportunity particularly into the IGT, and some of the energy sectors that we were not in previously, which opened the door with the Stellite acquisition from a platform perspective.

We think that will help us in the second half as we go forward, because that will be embedded in the organic growth.

Can you give us an update of how your arrangement with Fastenal is working at this point?

Do you have much in there for expectations for 2013, and how is the rolling out of the product in professional systems working?

I would say that we met all our expectations which were aggressive expectations with Fastenal for 2012.

Do you have some idea of how big it was in 2012, or what the numbers looked like?

I think it is still small for us to quantify that.

However, we have very high expectations going into 2013 with Fastenal, but again it is a low percentage, but the growth percentage is tremendous.

It is a big growth percentage.

Eli, I would expect Widia sales to do better in 2013 than they did in 2012, if that helps you.

Okay.

And just a final question.

Can you talk a little bit about the ability to sustain profitability?

I mean you started to give numbers that are quite respectable, and even in this soft kind of market that we are seeing macro environment and what your expectations are for profitability.

I would assume it is basically just to hold profitability in 2013 more than any major expansion?

I would start by saying without Stellite our EBIT margin was over 17%.

So if we had zero organic growth going forward, we should be able to maintain the 15%.

Then when you put Stellite on top, which I mean is, we are pretty optimistic and confident that we can be a 15-plus percent EBIT margin, even if we don't experience growth.

The other thing I will add there, we do have some investments, Eli, built in, the combination of head count and some strategies, we obviously can control those.

We can defer them if there is further softening, and I also anticipate raw material costs particularly in the second half should come down on a year-over-year basis, so we should see that benefit come through in addition to what Carlos said.

So just a couple of points there.

Your next question comes from the line of Ann Duignan with JPMorgan.

Hi, guys.

It is Mike Shlisky filling in for Ann today.

How are you doing, Mike?

Good, thanks.

So we have been seeing a few press reports recently about potential lack of availability of tungsten coming out of China, they have been concerning about exports on certain rare earth materials.

Wondering if you have seen any impact to your supply chain from those kinds of reports that have been coming out?

Yes, first of all, we have not seen any interruption or any difficulty in getting tungsten.

I also like to remind you that more than 50% of our tungsten that we buy, it could go up to even 75% of our tungsten that we acquire comes from western sources that rely significantly on working scrap.

In other words, taking scrap and turning it into material.

So we do not see or anticipate an issue with getting raw materials.

The only thing, Mike, I would add to that is, of course, there is talk in the US of releasing some strategic stockpiles, and Governor Casey is trying to make some noise in the US.

The blessing in disguise is as you know we have been chasing our inventory down all year, so we focused on finished goods, and we probably have an adequate supply of tungsten at this point.

I don't see any near term issues, and if anything the price should continue to stay where it is at, or potentially go down later on.

Okay, great.

Thanks.

Just a second one here.

From your comments earlier about North American transportation, can you break down for us which areas of that end market are kind of doing better than others?

Probably the automotive in North America continues to increase production.

As you know, we participate in the new projects yet to come.

Our facility in Solon, Ohio is near capacity with new projects that are going to be deployed in the next 12 months, which continues to show us, and the quoting activity continues to show us that market is going stay robust.

As I said in Europe, we participate in the high end cars, the German cars, that is going pretty much stay flat, and we are starting to see a rebound in the automotive in China as well.

Okay, guys, thanks so much.

Thank you.

Your next question comes from the line of Adam Ullman with Cleveland Research.

Hi, guys.

Good morning.

How are you doing, Adam?

Good.

Frank, congratulations on getting the inventory down.

I am wondering if there is an additional earnings impact from that in the fourth quarter?

I might have missed it.

And then is there, what is built into the guidance for this year in terms of inventory reduction, both the impact to earnings and then what do you think you can get absolute dollars down by?

Let me start with the fourth quarter we are down 21 and that I would say is a combination of finished goods and some raw materials there.

I would say the second half impact was about $0.07 per share.

Most of that which happened in the fourth quarter.

So we think that is pretty much behind us from that perspective.

As we go into fiscal 2013, right now I want to reduce inventory at minimum 10%, so I am talking about $60 million approximately.

And the related unfavorable absorption is already built into the plan, so there is no significant impact that I would call out.

But we will continue to focus on reducing inventory.

Not the big area for cash flow generation as we go forward.

I think from both the SAP system, our internal processes, and aligning free operating cash flow with the bonus metrics, I think we will get the desired behavior as we go forward.

Has there been any impact to the fill rates from taking down the inventories?

Yes.

Our fill rates have improved significantly.

And then just a clarification on the tax rate.

How should we be thinking about the earnings progression through the year between the US and international earnings, it sounds like the domestic earnings are going to be a bigger chunk of earnings this year, unless there is some other type of adjustment.

Frank, could you just kind of walk through that, how that plays out this year?

I think you are right.

I think with the benefits of our European structure being down a little bit, and hiring comes in other jurisdictions, that is going to put a little bit of pressure on it, and I think we have that pretty well in line with the 40/60 split with our earnings back at the mid point.

We should be in there.

Can we get a couple of discrete benefits which we would call out maybe short-term if we can resolve a couple of things, which I wouldn't put necessarily in the guidance, and then the other wildcard would be in the United States, if they decide whether it is in the lame duck session, or after the election if they decide to do something with the RD&E credit.

I have not built anything in, nor are we allowed to build anything in the tax rate as we go forward.

If you take the discrete items out, Stellite had an overall effective higher tax rate above Kennametal's, so most of the 24% to 25% reflects the impact of Stellite, expects the earnings switch there, and we have any potential upside it will be from some discrete items, maybe in the first half and depending what happens with the election.

Great.

Thank you very much.

Thanks.

Your next question comes from the line of Julian Mitchell with Credit Suisse.

Hi, guys.

It is Charlie Clark for Julian.

Hi, Charlie.

How are you?

Good, thanks.

Seemed like the European businesses held up pretty well in the June quarter.

Just didn't know if you had kind of any color on the last three weeks in those businesses?

I mean I think so far, what we see is aligned with our guidance.

I want to say that you guys follow our orders, we put orders in the first two months of each quarter.

The orders are very, we have as an example this quarter the first two months of the quarter were very challenging, and June was a great month for us.

And so we try not to predict or react too much to one month or another, because I think the customers are, our fill rates are very good.

So the customers tend to get the stuff from us, order stuff when they absolutely need it, because they know we are here and we are going to deliver for them.

So as a result of that, we see within the quarter pretty good months and pretty bad months, and this has taken place for the last couple of quarters.

So I would judge where we are today to, I wouldn't read too much into everything, to anything.

But we feel good about Europe.

And I remind everyone that the majority of our sales come from Germany in Europe, which is a blessing right now, and Germany continues to hold their own.

I would add.

I think some of the newer products and the strategies that the European leadership team is doing is continuing to drive very good results, and I think as Carlos talked about some of the steel plants, whether it was Solan or whether it is Lichtental in Europe, we are seeing a lot more activity in the steel plants which is a very good leading indicator for us as we look at our business because if they are making tooling, they are eventually going to go into the energy markets, aerospace, transportation, and later on you get the pull through when you put the inserts in the pockets, and given the automotive and transportation set that Carlos alluded to there is going be an opportunity.

I would think it as a combination of the transportation and global map, some of the business and the infrastructure is actually still hanging in there.

Great.

And then just curious just kind of that IPI forecast that you guys put out for the 3.5% or the 3.4%.

Is it fair to say that if we kind of look at IPI by region that your regional forecasts are pretty similar to those as well?

Kind of 1.5 to 2s like the regional IPIs, or is there any kind of --?

I will start and Carlos can add, we look at it I would say the Americas is a little bit below that.

We expect western Europe to be flat to slightly negative, particularly in the first half of the fiscal year, and then it gets a little bit stronger in the March and June quarter.

Then I would say Asia we are assuming for global industrial production like a 6ish kind of number there.

So when you take the Americas out a little less than 3, a slightly negative Europe front half loaded, and the overall Asia is about 6 to 7 in that range, that is where we are getting to that 3.4% with the sequential like i said the toughest part is the September quarter, and then it is pretty much consistent as we go out with one or two offsetting the other.

And this goes to show you that our guidance already assumes that Europe is not going to do as well.

The next question from the line of Steven Stone with Sidoti & Company.

Hi, how are you guys.

Good.

How are you doing?

Good.

Just a quick question, two questions actually.

First, can you speak more about raw materials?

Have you caught up in prices?

I thought you had already done it in industrials?

I think we are pretty much aligned as we have said, we probably were a quarter behind but as we ended the fourth quarter as reflected in the sequential improvement in the infrastructure margin we think we are pretty much where we need to be.

APT has been basically this is market not what we pay, but the APT prices have been in the range of 390 to 415, and at this point it has been somewhat stable.

We think we are where we need to be.

Okay.

And then can you just talk more about what you are seeing in the Asian markets?

I guess especially recently it looks like we are seeing a slower growth there as well?

Yes, I think that we experienced that in the fourth quarter and it is obviously reflected in our results.

I also remind the comps from our fourth quarter were very, are very high in Asia so we continue to see some growth, like Frank said, when we look at 2013 we anticipate IPI to be about 6%.

So we feel that the automotive is going to continue to drive that, the automotive industry.

So transportation.

As well as we think that the energy and mining is going to come back for the second half of the year.

Actually the infrastructure business has done pretty decent in China.

Both mining as well as surface mining which was a strategy to get into the adjacencies.

And what I would say was probably the softer spot was I'll call it local manufacturing in China.

So we saw the domestic auto manufacturers a little bit softer, and we expect them to pick up here when the new person takes over in China.

The new government.

Your next question comes from the line of Brian Rayle with Northcoast Research.

Good morning.

Hi, Brian, how are you doing?.

Good.

Most of my questions have been answered, but you guys had kind of said historically that you could do about $3 billion in sales with the current footprint, and it is a good problem to have, but you are kind of getting close to that.

Is there, does that theoretically move up from here, or do you think you need to start adding more capacity?

We are forecasting $3-plus billion in sales you have got to consider 300-plus is in acquisition.

Right.

It probably is the capacity utilization is probably at 50% to 60%.

So that gives us a little more there.

Okay.

And every year through lean benefits we get about 4% to 6%.

We free about 4% to 6% in capacity.

So to the extent that it is going to take us until next year, or the year after to get to like $3.5 billion, so it is sort of the new number that we are looking at as a result of the acquisition.

Okay.

Got you.

So you could do $3.5 billion total including, okay.

Yes, total.

Yes.

Okay.

So basically since you I think you gave that number out in 2008 the $3 billion number, we can grow that at around the mid point of say 5% a year since 2008 to get kind of what the core or previous Kennametal was at?

Yes, I mean directionally right, yes.

Okay.

Great.

Thank you.

Your next question comes from the line of Steve Barger with KeyBanc Capital Markets.

Hi, good morning, guys.

Hi, Steve.

I have been jumping around on a couple of calls so if these have been asked just let me know.

But thinking about your sales in Asia or China specifically, I know you expect to outgrow industrial production, but will that growth by the same magnitude as what you did last year, or is your relative growth rate changing in any of the regions?

It is about the same.

I think the one area that is going to probably do better is India.

But not by much.

Steve, the other thing we did put some investments in Australia as we continue to look at call it the earthworks component whether it is mining, we put a new facility up in [Bateau] China for drums.

So I think a combination we should see a little bit of a pick up there between surface mining, as well as some of the drums on the earthworks side in Asia.

So that should be a little bit stronger as we get into a little bit more capacity in these smaller facilities.

But everything else I agree with Carlos.

So if North America were to moderate a touch more, do you think you would pick up share or just kind of maintain where you are relative to the cycle?

I mean one of the things is if we are outpacing industrial production that implies that we are gaining share, and so our forecast going forward shows that IPI is going be slightly lower in North America versus about this past year.

So our growth is moderating in North America but we are still outgrowing at least 2 times IPI.

The North America piece as we talked earlier I think Widia should help us, it will grow faster on the Widia side with the Fastenal and the value-added resellers, and I would expect in the second half of 2013 particularly some of the highway construction build to pick up in there, we are also seeing some signs of some life in some energy just looking at some I'll call it steel projects, and some of the orders we are seeing relative to energy.

It is up so we think maybe that is either the I'll call it the December quarter, or early part of 2013.

Great.

And one last one.

Nice to see the increased buyback authorization.

Did you guys talk about a specific trigger that will cause you to get more aggressive, or is this more mechanical in terms of reducing share count?

Did you already talk about that?

We will follow our strategy of redeployment.

Obviously has to do with where we are in the acquisition pipeline, and where the share price is, and so forth.

So again, I encourage everyone to look at what we did in 2012 which was we bought 2 million in the first quarter, and made a large acquisition in the third quarter.

And by the way increased dividends last year we increased the dividends this year again.

So we want to have the flexibility of if the acquisitions don't come through, and the stock doesn't do better, obviously we have the ability to provide up to the full authorization.

Got it.

Thanks very much.

Your next question comes from the line of Justin Ward with Wells Fargo Securities.

Hi, guys.

Hi.

You kind of answered my question which what are you are you guys seeing that gives you the conviction that your sales to North American energy and mining markets hit bottom?

I think you just mentioned you are seeing some improved orders there.

Can you elaborate on that a little bit?

I think our quotes are very strong.

I think our orders there lead to the sort of the steel orders are leading into are an indicator and leading into our insert sales and all of that stuff are strong.

I want to continue to remind everyone our forecast models are pretty good.

Last year we, a year ago we forecasted pretty close to our forecast.

Even though the IPI and all of the stuff is going on, we went significantly down, we still deliver 3 times the IPI.

So we have a fairly good level of confidence in the guidance that we are giving.

And again, consistent with the previous years.

40% in the first half.

60% in the second half is mainly due to work days, vacations in Europe, and all of that stuff, and that is pretty much historical.

And that 40 to 60 does that apply to sales as well as EPS?

No, sales is anywhere from 47 to 48 in the first half, and then the remainder in the second half.

That has been kind of the split.

And then just one last quick one.

You talked about EPS impact of currency next year.

What are you expecting for the topline?

I would say it is almost 4% of topline sales.

That is over $100 million.

It is a big impact.

Great.

Thank you, guys.

Your next question comes from the line of Doug Thomas with Jet Investments.

Hey guys, congratulations on a good quarter and I actually thought this call was outstanding.

Very informative.

A lot of color.

I appreciate all of that.

And I appreciate you allowing me, I know you are probably over the time limit to ask a question.

But Carlos I think sometimes people, investors analysts in particular lose sight of the big picture, and one of the things that has always impressed me about Kennametal in the years that I have covered the Company is the direct alignment between compensation and performance, the significant insider ownership, and the fact that you guys spend money in general and make investments like it was your own money, as opposed to many other companies out there.

I think maybe it might be helpful if you could just because a lot of guys don't read proxies, and don't pay attention to much of this stuff.

I mean obviously with the stock having come in from where it was and trading at the valuation that it is currently trading at, I think maybe you should remind people about the fact that you do have direct alignment and that you guys are consistently acting in the best interest of shareholders when it many comes to running the Company.

The point is, that is a good point.

Obviously our compensation is very mechanical to be honest with you.

It is formulaic, and so whatever guidance it is, our compensation depends on that guidance.

So we would not think of giving guidance that we did not have a very strong conviction to that guidance, because at the bottom of the line it is going to cost us in our pocketbook significantly, and for me personally as you can read in the proxy, my compensation is close to 70% at risk, so there is a big incentive for me to be very cautious about the guidance that I put up there.

So there is a lot of work that goes on.

Like I said, even if you look at last year, we had the same questions that we had last year and we kind of don't believe your guidance is too aggressive, growth and all that stuff and guess what.

And by the way, it turned out to be much worse than we thought back then about the whole economy, and here we are.

We met all of the objectives, and so we feel very good and Doug I appreciate your words, because that is so true.

Thanks very much.

I appreciate all of the effort.

Thanks, Doug.

Your final question comes from the line of Henry Kirn with UBS.

You mentioned that Widia grew 12% last year.

What kind of growth expectation is in the guidance for Widia for 2013, and can growth rates is remain at or above 2012 levels?

Higher.

It is going to be higher than those levels is.

One of the reasons for that is last year we also had some product that we moved from Widia to Kennametal, so this year is going to be a like to like and is going to show us a higher growth, but we are not going to specifically talk about that for competitive reasons the exact number, but it is higher.

That is helpful.

Forgive me if I missed this.

What share count is the EPS guidance predicated on?

It will be down a little bit, Henry.

2.4 million.

As Carlos said, probably between $2 million to $2.5 million evenly over the quarters that is for planning purposes, and then we typically issue like 800,000 shares that happen in the first quarter.

So at minimum we will be doing $2 million to $2.5 million that is what is in our plan, and as Carlos said, consistent with our priority uses of cash depending on the acquisitions and the timing we could accelerate it, or we will see how we best apply our funds.

Thank you very much.

Thank you.

Our Q&A period is now complete.

I will now turn the conference back over to Ms. McGuire for any closing remarks.

Thanks, Regina.

This concludes our discussion.

Please contact me, Quynh McGuire, at 724-539-6559 if you have follow-up questions.

Thanks for joining us.

Today's call will be available for replay beginning at 1 PM Eastern Time today and lasting through Midnight Eastern Time on August 27, 2012.

The conference ID number for the replay is 94110120.

The number to dial for the replay is 855-859-2056 or 404-537-3406.

This concludes today's discussion.

Thank you for your participation.

You may now disconnect.