Kennametal Inc. (KMT) Q1 2009 Earnings Report, Transcript and Summary

Good morning and welcome to Kennametal's First Quarter Fiscal Year 2009 Earnings Conference Call. My name is Stephanie, and I will be facilitating the audio portion of today's interactive broadcast. All lines have been placed on mute to prevent any background noise. After the speaker's remarks there will be a question-and-answer session. [Operator Instructions]. At this time, I would like to turn the event over to Ms. Quynh McGuire, Director of Investor Relations. Ms. McGuire you may begin your conference

Thank you, Stephanie. Welcome everyone. Thank you for joining us to review Kennametal's first quarter fiscal 2009 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 process in prior quarterly teleconference 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 November 23rd, 2008. 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 of Finance and Corporate Controller, Wayne Moser. Carlos and Frank will provide details on the quarter's financial performance, as well as our outlook for the remainder of fiscal 2009. After their remarks, we'll be happy to answer your questions. At this time I'd like to direct your attention to our forward-looking disclosure statements. 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 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 matters during this call, in accordance with SEC Regulation G. This 8-K presents GAAP financial measures that we believe are the 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. Good morning everyone. Thank you for joining us. In contrast to the volatility in the economy, and the financial markets, the first quarter of fiscal 2009 was another period of solid performance for Kennametal. We further strengthened the foundation of our company by investing in our business and driving additional operational efficiencies. We also continue to have a strong balance sheet. At the same, time we deliver on our commitments relating to sales growth, earnings per share, and return on invested capital. We have often said that Kennametal is a strong and resilient company, that is better positioned than many, to withstand market challenges and difficult economic cycles. Over the past several years, our management team has executed strategies to increasingly balance our geographic presence, business mix, and served end markets. Those strategies were proven in the September quarter. We achieved organic sales growth of 3%, and again, set a new sales record. This represents our 19th consecutive quarter of year-over-year organic growth. We reported EPS growth of 10% on an adjusted basis, despite higher raw material costs year-over-year and a challenging economic environment. Our return on invested capital was also higher by 70 basis points compared to the prior year. In addition, SG&A expenses, as a percentage of sales declined 60 basis points from the prior year. This marks the 11th consecutive quarter, in which we had year-over-year improvement in this key metric. Our first quarter performance provides clear evidence that we have made the appropriate structural changes to our business, changes that have improved Kennametal's resilience and ability to manage through the various economic cycles. Our global team has sustained a market leading pace through our intense customer commitment. We continue to meet our goal to generate 40% or more of our total sales from new products. In fact, we introduced approximately 2,500 new products at a recent international manufacturing technology show in Chicago, an important metal working industry event. Kennametal's new products have been shown to improve the productivity of the products they replaced anywhere from 30%, up to 1000%. Equally important, we have also successfully reduced our product development cycle time. This enables us to get new products to the marketplace faster, which helps customers to be more productive sooner. Our customers recognize the performance and value of Kennametal products and services. As a result, we have been able to successfully implement necessary price increases and maintain our margin discipline. Another way we bring value is through our recycling initiative for key raw materials, which has resulted in a considerably hard savings for us and our customers. This is a component of our Protecting Our Planet Program, which drives additional cost savings for Kennametal to reduced use of natural resources. Our efforts in this front have been recognized through a Green Manufacturing Award from Frost and Sullivan, a market research firm known worldwide; an important part of our resilience as a company is our focus on sustainability. Regarding geographic markets, the North American economic environment continues to be challenging, with the current financial turmoil as well as the recent European [ph] activity. The credit crisis has also impacted Europe, and economic growth there is expected to be relatively flat. We remain watchful of the market conditions in that region. In our rest of the world markets, there seems to be some slowing, but it is still a favorable growth environment. Regarding some of our key end markets, aerospace continues to experience growth, despite the ongoing strike. For the natural gas market, the Baker Hughes Drilling Report is showing year-over-year growth in both North America and Canada, with the international rate count higher. In underground coal mining, US prices and demand continues to be strong. We will continue to be very focused on maintaining a strong balance sheet and a high level of liquidity, together with making further investments to maximize shareholder value. Our cash usage will include a combination of CapEx, restructuring related expenditures, dividends, and acquisitions. We will continue to invest in our business to enhance our productivity and capability. At the same time, we are streamlining our manufacturing footprints and otherwise reducing costs. While previously, we reduced our footprint on a pay-as-you-go basis, we accelerated this strategy to take advantage of the slowing sales environment. As part of our previously announced restructuring plan, we have subsequently initiated or completed closure of six facilities, four of which were in North America and two were in Europe. We've also initiated certain other cost reduction programs. We expect those restructuring actions to result in further operational efficiencies to reduce our costs to serve and maximize our profitability. As an update to our share buyback program, we bought back 4 million of our shares in the September quarter and completed our share repurchase authorization. On October 1st, 2008, we acquired Tricon Metals and Services to expand our advanced material segment. Tricon is a leading provider of proprietary custom ware solutions to the surface and the ground mining markets. I want to emphasize that we'll remain disciplined in our portfolio management process, with a bias towards preserving cash and maintaining strong liquidity. Kennametal's competitive advantages are best defined by the commitment to our global team, our focus on innovation, and the strength of Kennametal Value Business Systems or KVBS. We continue to adhere to a disciplined approach of KVBS, our management operating system. The combination of our proven strategies, disciplined processes, and dedicated people, provides the foundation for Kennametal's success now, and in the future. I will now turn the call over to Frank, as he can discuss our financial results in greater detail. Frank?

Thank you, Carlos. I'll provide further comments on our performance for the September quarter and then I'll move to the outlook for the remainder of the fiscal 2009 year. Some of my comments will exclude both current quarter and prior year special items, and you can refer to the 8-K for additional information. So to summarize, sales gains in all major metal working markets outside of North America, as well as strong sales growth by our advanced materials business, more than offset the impact of weaker market conditions in the North American metal working market. We also considerably improved and gained momentum with our price realization, particularly in our advanced materials business. Furthermore we benefitted from a lower tax rate, and continued to invest in our business, while also repurchasing 4 million shares, which completed our board authorized share repurchase program. And as a result, we delivered a record September quarter for sales, adjusted earnings per share, and adjusted return on invested capital. Consistent with our previously announced restructuring plans to reduce costs and improving efficiencies in our operations, we recognized pre-tax charges related to these initiatives of $9 million or $0.10 a share during the September quarter. This brings our total restructuring and related charges to date to $17 million. Including these charges, we still expect to recognize a total of 40 million to 50 million of pre-tax charges related to these restructuring actions. The remaining charges are expected to be incurred over the next six to 12 months. And as you know, the annual ongoing benefits of these actions, once fully implemented, are expected to be in the range of 20 million to 25 million, and we feel we are on track with all these initiatives. Now I'd like to walk you through the key items in the income statement. Sales for the quarter came in at $669 million, compared with $615 million in the same quarter last year. Our sales grew 9% year-over-year and included 3% organic growth, 5% from favorable foreign currency translation effects, and 2% from more work days, partly offset by the impact of divestitures. MSSG sales increased 6% during the September quarter, driven primarily by favorable foreign currency effects, which increased sales by 6%. Increased work days added a further 2%, which was offset by the impact of divestitures last year. On a global basis, our industrial activity is mixed. Activity in certain industry market sectors including aerospace, defense, and energy remain positive, while others such as automotive and other durable goods were somewhat weaker. Regionally, organic sales growth was led by Asia-Pacific at 22%, followed by Latin America, India, and Europe at 7%, 6%, and 2% respectively. This offset a reduction in North America organic sales growth of 8%. The decline in North American sales is primarily attributable to lower sales to distribution, resulting from higher fill rates, driving down inventory levels, as well as our overall market conditions, and to a lesser extent the Boeing strike and recent hurricane activity in the Gulf of Mexico contributed to the North America decline. Our Advanced Materials Group sales increased 15% during the September quarter, and that was driven by 10% organic growth, 3% from favorable foreign currency effects, and 2% from additional work days. Organic sales increased on stronger mining and construction sales, and higher energy related sales, slightly offset by lower sales of engineer products, and surface finishing machines and services. Turning to our gross margin, our improved price realization exceeded the increase in raw material costs for the quarter. However, the spread has not yet reached the point to fully eliminate the overall margin dilution, caused by higher raw material and freight costs, which was about 50 basis points for the quarter. Another item which contributed to the year-over-year margin impact were temporary disruption costs related to our plant rationalization and restructuring initiatives, to which both Carlos and I referred to earlier. We estimate that those distribution costs related in our gross margin by about 40 to 50 points for the quarter. The remainder of the items contributed to the gross margin percent impact included some business mix, and some lower manufacture and production. I'll once again mention that our price recovery of high raw materials… higher raw material costs exceeded 100% during the quarter, resulting from pricing actions implemented in fiscal 2008. We have gained good momentum here, and our price recovery has doubled sequentially from the fourth quarter. Further pricing actions have been implemented just this month, and additional actions are planned for fiscal 2009. As we had anticipated, it appears that prices for certain of our key raw materials may now have peaked. This trend would be consistent with our previous expectation, whereby our raw material costs would be higher year-over-year for the first half of the current fiscal year, but lower in the second half. Our operating expense increased 6% or $9 million to $154 million from the prior year quarter. The increase is mainly attributable to foreign currency exchange rate fluctuations. Our operating expense, as a percent of sales, decreased 60 basis point to 23% from 23.6% in the prior year quarter, and as Carlos mentioned, this represents the 11th consecutive quarter, in which we have made a year-over-year reduction in operating expenses as a percent of sales. We also recognized restructuring charges of $8 million during the September quarter related to the actions mentioned earlier. Our operating income was $53 million for the quarter. This represents a decrease of $11 million or 17% from $64 million in the prior year quarter. Absent the impact of restructuring and related charges, operating income for the quarter was $62 million, or 9.3% of sales. Compared to the prior year quarter, operating income was lower by $2 million and decreased 110 basis points as a percent of sales. The decrease in our operating margin percent was mostly due to the previously mentioned impact on gross margin of higher raw material costs, temporary disruption costs, and other items offset by lower operating expense as a percent of sales. Further momentum with price realization, restructuring benefits and ongoing cost controls should all contribute to improve our operating margin going forward. MSSG's operating income decreased 22% and the operating margin decreased 360 basis points from the same quarter last year. During the September quarter, MSSG recognized restructuring and related charge of $7 million, absent these charges MSSG's operating income decreased 9% and operating margin was down 190 basis points. The primary drivers of the decline in operating margin were the temporary disruption effects related to the restructuring initiatives, and higher raw material costs, offset by current quarter benefits from price increases, and favorable foreign currency effects. Price realization in MSSG, which was higher and should offset further price momentum as price increases take effect, did not yet reach the point of fully offsetting the increase in raw material costs. AMSG's operating income was level with the prior year, while their operating margin was 190 basis points lower. During the September quarter, AMSG recognized restructuring related charges of $1 million. Absent these charges, AMSG's operating income increased 5%, and the operating margin decreased 130 basis points. The decline in operating margin was due to unfavorable business mix and lower performance in the engineered products and surface finishing machines. Improved price realization more than offset the impact of higher raw material costs. And then our corporate operating loss decreased by 6% or $1 million. Interest expense of $7 million decreased 9% from $8 million in last year's comparable quarter. The impact of an increase in our average domestic borrowings of $111 million, was more than offset by lower average interest rates on our borrowing. The increase in our average domestic borrowings was driven by the repurchase of 4 million shares at a total cost of $127 million. Our total debt at September 30th, 2008, of $482 million was up $105 million or 28% from a year ago. Our other income expense decreased 2.5 million from the prior year quarter, primarily due to higher foreign currency transaction losses, as volatility in many of the foreign currencies, in which we trade, reached extreme and perhaps unprecedented levels in the September quarter, as a result of turbulence in the global financial markets. These unanticipated currency transaction losses unfavorably impacted our EBIT margins by about 40 basis points. Our effective tax rate for the quarter was 19% compared to 38% last year. The prior year rate was unfavorably impacted by a charge related to a German tax law change. Absent that charge, the prior year tax rate was 26.3%. The reduction from the prior year rate was due to a release of a deferred tax benefit valuation allowance, which was anticipated as part of our full year projected effective tax rate, and increased benefits from the company's Pan European business strategy. Lastly, reported fiscal 2009 first quart diluted earnings per share were $0.47 compared to $0.44 in the prior year quarter, up 7%. The current quarter reported earnings per share included charges of $0.10 related to our restructuring action. The prior year reported earnings per share included a non-cash charge of $0.08 per share for the impact of the German tax law. Absent these charges, adjusted EPS for the current quarter of $0.57 increased 10%, compared to the prior year adjusted EPS of $0.52. To provide additional perspective on earnings for the September quarter, a high level bridge from the midpoint of our guidance range of $0.50 to $0.55 per share to our adjusted EPS of $0.57 per share, was driven by our operational performance which was better by $0.03, which was essentially offset by the impact of the foreign currency translation effects, that I previously mentioned. Our lower effective tax rate contributed $0.03 per share, and our lower outstanding count from our share repurchases added $0.02 per share. And our adjusted return on the capital of 12.3% was up 70 basis points from 11.6% in the prior year quarter. Our balance sheet remains strong and we continue to generate strong cash flow from operations. At September 30, 2008, our debt-to-capital ratio was 24.5%, which provides us with substantial financial flexibility. We generated $38 million of cash flow from operations during the September quarter. Our cash and cash equivalents were 69 million as of quarter end, down $18 million from June 30th, 2008. As I said earlier, our total debt ended at the quarter at $482 million, that's up $135 million from the June quarter, and this increase in borrowings was primarily used for share repurchases. And as I mentioned, cash flow from operating activities was $38 million, which compares with $57 million in the prior year quarter. Free operating cash flow for the current quarter was an outflow of $5 million, compared with an inflow of $60 million in the prior year quarter. The change in free operating cash flow is primarily driven by a reduction in accounts payable, and changes in assets and liabilities. The strength of our balance sheet as well as our proven capability to generate strong cash flow from operations, enables us to weather tougher economic times, and affords us ongoing flexibility to further develop our business. We will continue to remain diligent with our use of cash and capital deployment, especially, as we navigate through this period of uncertainty in global markets. We also have no near term refinancing needs and no exposure to the CP market. Maintaining our strong balance sheet, solid investment grade ratings, and ensuring adequate liquidity will of course be among our highest priorities. We have reviewed and continue to carefully review our capital spending, and we have already taken steps to reduce spending in certain areas. Nevertheless, we will continue to prudently invest in our business, to further enhance our competitiveness, productivity and capability. At the same time, we'll drive forward with our restructuring actions to further improve performance and reduce costs. And finally we will continue to evaluate strategic and attractive acquisition opportunities, such as our present purchase of Tricon. Also today our board of directors also declared a regular quarterly cash dividend of $0.12 per share. Now I'd like to turn to the outlook. Our proven strategies will continue to make us more resilient and serve us well as we move through the current period of turbulence in the global markets. Our customer base is broad, our end markets are diverse, and our geographic balance has never been better, and our balance sheet is strong. Nevertheless, we believe that it is appropriate at this time to reduce our earnings outlook given the existing level of uncertainty in the global economy. Throughout this period, we will continue to manage our cost structure, commensurate with prevailing business levels. We have revised our EPS outlook for fiscal 2009 to a range of $2.75 to $2.90, excluding charges that occur relating to our previously announced restructuring actions, and organic sales growth is expected to be 0% to 2% for fiscal 2009. We anticipate the full year tax rate, excluding special charges to be between 21% and 22%. This revised outlook includes the benefits of the reenactment of the RD&E tax benefits, that recently occurred in our second quarter. We anticipate the second quarter effective tax rate to be around 21%, and the effective tax rate for the second half of our fiscal year is expected to be between 22% and 23%, excluding special charges. For our second quarter, we expect organic sales growth rate to be 0% to 2% and EPS to be in the range of $0.51 to $0.56 excluding charges that occurred for the restructuring actions. We anticipate cash flow from operating activities of approximately $290 million to $310 million for the full year, based upon anticipated capital expenditures of $145 million, we expect to generate between $145 million and $165 million of free operating cash flow for fiscal 2009. At this time, I'd like to turn it back to Carlos for some closing comments.

Thank you, Frank. As we advance through the rest of the fiscal year 2009, we'll keep positioning Kennametal for more profitable growth. We will capitalize on the strength of our balance sheet and focus on realizing further improvements, with a strong bias towards cash flow and liquidity. We are continually managing our portfolio, and building on our core business. We're also expanding various end markets, and grow our geographic mix in developing economies, such as China and India. In addition, we'll remain aggressive in addressing key issues, such as raw material cost recovery, which we are addressing through pricing actions, green [ph] savings and strategic sourcing. We recognize that there are challenges ahead. However, we believe that our cost control focus and strong fundamentals will provide us with the ability to successfully execute our strategies and meet our commitments. We have transformed Kennametal over the past several years into a company that is well prepared to manage through a downturn. We fully understand the importance of liquidity and having access to capital. Our consistent cash flow generation and a balance sheet quality, provide Kennametal with significant financial flexibility. Our product portfolio is more competitive than ever, and our fill rates are at record levels. Our manufacturing capability and quality are also at historical highs for the company. Our market coverage for both direct and indirect channels is better than ever. In addition, we continue to grow our presence in emerging markets Finally, Kennametal's global team, our most competitive advantage, has been redeployed to maximize selling opportunities. In summary, I believe that Kennametal is well positioned to outperform under difficult market conditions. I also believe that, in the current volatile market, this makes Kennametal a compelling investment story. Thank you for your time and your interest in Kennametal. We will now take your questions. Thank you. Question and Answer

[Operator Instructions]. And the first question is from Walt Liptak from Barrington Research. Your line is open sir.

Thank you. Good morning everybody

Hey Walt.

Good morning Walt

My question is on pricing, and during the quarter, the 3% organic, how much would you say was related to price?

I'd say Walt, at this time, it's about 50-50. So we've gained some pretty good momentum there, particularly as I said, in the advanced materials side of the house. But pretty much right down the center, at about a point and a half each way

And in the guidance assumption of 0 to 2% organic, what are you… what's the pricing strategy… what's happened to tungsten and cobalt? How much price are you expecting in the rest of the year?

Well from the price… I think at the beginning of the year, we had said we'd like to get a net of 2, and we still are on track to meet that or potentially exceed it. In some accounts we're definitely walking away from a profitability, as part of our strategy. But overall, we feel we're on track for that. Raw materials, tungsten has not really changed that much. Cobalt, while it's come down from our second half of last year, as we had anticipated, it's still slightly higher on a year-over-year basis. So that continues to trend as we had expected. And then I would say from steel… steel's still increasing. We're still getting some cost pressures, but I would say that it's less than it's been in the previous quarter. So that's trending we think in a favorable direction

Okay. So in your EPS guidance, you're looking for volumes basically to be flat year-over-year in… over the next three quarters?

Correct

Okay. Yeah, I guess the question is, why wouldn't you have taken those numbers down even more, given the deteriorating outlook for industrial?

You know Walt, we just… three weeks ago we finished the first quarter and we grew 3%. And so far, our sales are in line with our expectations in this quarter. So I think that's based on the visibility that we have and the markets that we serve and that geographic balance, we feel that that's appropriate.

Okay, fine. And then if I could just ask one more, corporate expenses are a little bit lower than… I was thinking that it was going to run around 100 million this year, and you came in at $20 million for the quarter. What's your expectation for this year?

Yeah. I mean, it may tick up a little from that level, but I think it'll be down and given the revised outlook. As you would anticipate compensation programs are basically tied to the performance of the business unit, so that will come down somewhat slightly. And then I think the rest is from a lot of the corporate business units or corporate functions, looking at the cost control. So it'll be down from the $100 million, and it may be up a little bit slightly on a run-rate going forward

Okay. Thanks guys

Thank you

The next question comes from Eli Lustgarten from Longbow. Your line is open

Good morning.

Hey Eli.

How are you doing, Eli?

Not too bad. A couple… one clarification. Was there a foreign currency net earnings gain in the quarter, or was it a net charge?

Basically for the quarter Eli, when you take the transaction and translation combined, it was basically neutral

That's why I asked that. And you have it neutral for the rest of the year, I assume?

Depends on…

Well did you have any?

Yeah. No, we have a slight negative from a… given where the currency rates have been trending, that's part of the reason that we reduced our guidance for the outlook. So I would say, that could be anywhere from $0.10 to $0.15 for the rest of the year.

Negative?

Correct

Okay. And then, I guess the question that we're asking, you're assuming relatively flat volumes, and if you have… if you're talking 0 to 2% growth organic and prices at 2%, you're really talking negative real volumes. Can you give much of an earnings lift if buying goes down 5% or 10% over the next couple of quarters? I mean, everybody's… the market's telling us we were [inaudible] to be very scared of this economic environment. And let's say, if we take a more harsh environment, where instead of volume… real volume being relatively flat, it's down somewhere at 5% plus. Can you still get some sort of an earnings lift over the first half in that kind of scenario? I mean, that's really the question that the market's looking to figure out?

I think some of the things… the volume… that's obviously tough to look out as you said. But from some of the actions we've done, from the pricing and the raw materials dropping down, plus some of the restructuring actions that we started initiating in the fourth quarter, and then kind of the… I'll call it the diligence we're looking at from cost, every discipline. We think that we can… short term we can manage that. And we've built some further reductions in, from a volume, for the rest of the year, and I think some of the capital that we've put in, in the past, have made us much more productive, as we go forward

Yes. And one final question. Shares outstanding at the end of the quarter, and is there any chance of any more buyback? I mean, you sort of have bargain prices if… when it doesn't begin with a two especially?

Yeah Eli, this quarter we'll probably… this month we were looking at liquidity and what's going on in the marketplace. We're staying very focused on liquidity. However both management and the Board is ready to act very-very fast, overnight too, if we need to… for a reauthorization

All right. And what are your actual share counts at [inaudible]? Anybody know what that is?

Sorry Eli, we couldn't hear the question

The actual share count at the end of the quarter?

Yeah. It was 75.5

Okay. Thank you very much

Thank you

Your next question is from Andy Casey from Wachovia Securities. Your line is open.

Good morning everyone.

Hey Andy.

How are you doing Andy?

Doing fine. How about you guys?

Very good

Good. A couple questions, first on margin and then on the outlook a little bit. On margin performance in the quarter for MSSG, you talked about several factors that drove the year-to-year decrease. If I exclude the restructuring of production/disruption, which I'm estimating is around $3 million hit. The contribution margin was around a negative 9 after being positive for each quarter last year. Was there an underproduction versus retail demand to pull down inventories in there or is the remainder just what you talked about cost versus price?

Yeah. It's more of the latter than the former. I mean, we've probably adjusted a little bit on the volume side on the North American business, particularly in the metal working side. But nothing unusual.

Okay. Then on the outlook, if I take first half second half, it looks… the next quarter you have something that looks like down year-over-year earnings, and then second half kind of looks up 10%. Is that because you expect the cost side to improve, relative to the second half last year? Or can you help us kind of understand that pattern?

Andy, it's a combination of cost and the price realization, that we always said that the two lines are going to cross at… in the middle of the year.

Okay

Andy, the only thing I would add to that… and Carlos is right. We will start to see some benefits from some of the actions with the restructuring that were started in the fourth quarter and which we continue to do. As Carlos said, we're in the process of rationalizing six facilities. So we'll start seeing some benefits in the second half of our fiscal year.

Okay. Thank you very much.

Thank you, Andy.

Your next question is from Mark Koznarek from Cleveland Research. Your line is open

Hi. Good morning.

Hey Mark.

Good morning Mark.

Could you just quantify how much those production disruptions costs were in the quarter? I think the prior quarter you said about $1 million?

Yeah. It was approximately in this quarter… last quarter I think I said it was… could be as high as $5 million. The actual amount was roughly $3 million

3 million for this quarter?

Yeah. In the September quarter. And if I looked out, it could be 5 to 6 in the second quarter.

Okay. And you had previously anticipated that to be like 13 for the…

For the year?

For the year, right. Okay.

Right. And I would say that 12 to 13 is probably still right.

Okay. That's good. So the answer to the previous question, we would expect to get net benefits in the second half?

Yeah. If you break it down into like the… Carlos said the cost, the price, the benefits and the lower disruption costs in the second half, that's part of the reason we would have better or improved earnings.

Okay. Let's see. The only other question I had was with regard to the surface finishing business. Given the weakness there, just the question is, how much intangibles and goodwill is associated with that business, and when's the last time they were tested? And is there an expectation that there ought to be some write down of the intangibles associated with that, with the weaker market outlook?

Appropriate question, I'll refer you back. We typically don't wait. If we see any weakness in any of our businesses, from some of the acquisitions, we test when we think we have a triggering event. That's what actually happened in the March quarter, where we took an impairment charge of $35 million, to write the surface finishing business down to what we felt was an appropriate value. That coupled with that $40 million to $50 million restructuring program was there's additional actions to further address costs in that business, coupled with a very strong management team that we put in place, we feel fairly confident that we have the business moving in the right direction. So at this point we just tested it. We actually accelerated the test for Extrude Hone in March. And as you know, all public companies have to test for impairment at the end of the fiscal year, which was June. We ran through all those tests again, and we don't have anything to disclose.

Okay. Pretty good. Thanks Frank.

Thank you.

The next question is from Henry Kern from UBS [ph]. Your line is open.

Good morning guys.

Hi. Good morning.

Could you talk a little bit about how inventory levels are at the distributors, and how you see distribution demand trending through the year?

Yeah. As I often talk, about our distributors carry very-very little inventory in our business model. And as a tradition, we ship from warehouses within like next day typically shipments. In addition to that, our fill rates are at an all time high. So as our fill rates have improved over the year, the distributors have less and less inventory. So when things turn, I mean, we'll see the impact in that into our production immediately.

Okay. And in this tougher credit environment, where would you be comfortable from a leverage perspective? I guess to glue one other thing on top of that, would you be comfortable making an acquisition in this market, or would you hold off until the credit environment returns to normal?

Yeah, I mean if we have the right acquisition at the right price, we would consider making an acquisition, based on what we know today.

But Henry, as Carlos reiterated I would say given the uncertainty right now, the focus is on cash and liquidity. And as opportunities arise, we'll look at them. But that I think is the near term focus.

Okay. Thanks a lot.

Thank you

The next question is from Steve Barger, KeyBanc Capital. Your line is open.

Good morning.

Hi Steve.

Just a question on the broader end markets. Thinking about the cadence of the US slowdown over the last 8 months, and what your guys in Europe are telling you about the slowdown there? Does it really feel the same or over the course of the last month, has it been markedly worse over there? Do you expect a magnitude of the same decline?

Did you say Europe?

Yes

Yeah. We've seen a decline, a continued decline. And what we see there, is that some of the consumers, some of the segments have weakened faster than others. The segments that we are playing in, are slowing down less. For example, the machine tool business is looked to be flattish versus down in the consumer and so forth. So it's pretty consistent with what we anticipated at this point.

Yeah Steve. The only this I would add there is… if you go a year ago, we probably had the highest organic growth rate for our Europe operations in the September quarter. So all things considered, it's a very challenging comp, number one. So they're still at a high level. But we have seen it continue to slow from the August timeframe.

Okay. Historically, your general philosophy has been to manage [ph] for margin rather than revenue. But with this broader economic pullback that we're looking at, is there any area or any product line where you might use price to drive volume and try and lock in some market share gains in the downturn?

No. I think that where we have the business, where we don't to drive for the margin are our businesses that in the long term, we don't want to be in. So we continue to look at realigning the portfolio and access some of those businesses. So we wouldn't want to get market share in those businesses. And where we'd… where we are strong and drive for margin, our value proposition is such, that we can get both price and volume at the same time.

Okay. One quick question on coal end markets. Those prices, coal prices themselves are off their highs. What are your customers telling you about coal production? Have you seen any slowdown in some of the uptick in those products?

Yeah. I just went to the Coal Mine Expo in Vegas in the last four weeks. And I tell you the excitement there was tremendous, and the sentiment was that the mining, it was going to be strong for the next 18 months. So, we continue to see that to be robust at this point.

Okay. And just one last one. What's the net facility number now, after you account for the six facilities that are going out?

You know I don't have that number handy here but, you know…

Steve, this is Quynh McGuire. I'll follow-up with you on that.

Okay, great. Thanks Quynh.

And the next question is from Rahul Sadiwala from Goldman Sachs. Your line is open.

Hi. Good morning.

Hi Rahul.

Good morning.

Hi. I had a quick question on the impact of the Boeing machinists strike. If you could kind of help us understand what the impact was this quarter, and your guidance going forward, what you are [ph] assuming for it?

Yeah. I wouldn't say it's a significant amount. There's some level of impact and it's tough to quantify, because through the distribution, we don't get all the inputs, point-of-sale reports directly to the aerospace sector. But I wouldn't say… as I said it had a minor effect in the quarter. But I don't think it's anything significant, either in the quarter, for the second quarter, or for the full year at this time.

Yeah. I'll also add that… I'll remind people that our percentage of sales in the aerospace market is relatively small, about 7%, in addition to Frank's comments.

Right. Okay, thank you. And just as another question, kind of following up on your prior comments, on your end market commentary for the guidance. So is it safe to assume that you are yet assuming that North American oil and gas is going to stay robust at the same rate, in your guidance currently?

Yeah. I spoke specifically on the mining. We look at energy separate. And again, we see energy continue to be very-very good.

Okay, great. Thank you very much.

And there are no other questions at this time.

This concludes our discussion. Please contact me, Quynh McGuire, at 724-539-6559 for any follow-up questions, and thank you for joining us.

Thank you for participating today's in Kennametal first quarter fiscal year 2009 earnings conference call. This call will be available for replay, beginning at 1:00 pm Eastern Standard Time today, through 11:59 pm Eastern Standard Time on November 23rd. The conference ID number for the replay is 68667454. Again, the conference ID number for the replay is 68667454, the number to dial for the replay is 1800-642-1687 or 1706-645-9291. And this concludes today's conference call. You may now disconnect. .