Kennametal Inc. (KMT) Q3 2011 Earnings Report, Transcript and Summary

Good morning. I would like to welcome everyone to Kennametal's Third Quarter Fiscal Year 2011 Earnings Call. [Operator Instructions] I would now like to turn the conference over to Quynh McGuire, Director of Investor Relations. Please go ahead.

Thank you, Tiffany. Welcome, everyone. Thank you for joining us to review Kennametal's Third Quarter Fiscal 2011 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 prior practice in prior quarterly conference calls, we've invited various members of the media to listen to this call. It is also being broadcast live on our website, and a recording of this call will be available on our site for replay through May 27, 2011. 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, Martha Bailey. Carlos and Frank will provide further explanation on the quarter's financial performance. 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 statement. The discussion we'll have today contains comments that may constitute forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve a number of assumptions, risks and uncertainties that could cause the company's actual results, performance or achievements to differ materially from those expressed in or implied by such forward-looking statements. Additional information regarding these risk factors and uncertainties is detailed in Kennametal's filings with the Securities and Exchange Commission. In addition, Kennametal has provided the SEC with a Form 8-K, a copy of which is currently available on our website. This enables us to discuss non-GAAP financial measures during this call in accordance with SEC Regulation G. And this 8-K represents 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. Good morning, everyone. Thank you for joining us today. We are hosting this call from São Paulo Brazil. Our Board of Directors and some members of our senior management team recently visited our manufacturing facility located near -- in the Atuba. Kennametal's established operations in Brazil in 1999 and we have continued to grow our presence in this region. I'm pleased to report that March quarter results continue to demonstrate that Kennametal's global team is successively executing our ongoing strategies. During the quarter, we realized organic sales growth of 25% on a year-over-year basis. Note that, that is against a strong top line comparisons from the same period in the prior year. In addition, we achieved the all-time records with operating margin of slightly over 15%, a return on invested capital of approximately 13% for the March quarter. Even with sales that are lower than our prior peak. The macroeconomic environment has been better than our expectations. Global business conditions remain positive throughout the quarter. Industrial production continues to show strength around the world and emerging markets such as China, India, and Brazil remain growth leaders. Specific to Kennametal, for the year-to-date period, we saw 39% of sales increase year-over-year in our rest of the world markets. Again, this growth is on top of strong comparatives from prior year. Regarding our served end markets, general engineering and transportation continue to expand. Our strong sales growth reflected higher customer demand in both our served end markets, as well as geographic regions. From a macro-perspective, growth remains strong in most areas. China and India continue to be very strong with China taking some measures in the near-term to control growth while India is well insulated from external events. In Brazil, the industrial production rate is expected to remain high. U.S. manufacturing production is forecasted to grow and the extra output is likely to show up in exports or added inventory. In the aero zone, growth mainly comes from strong momentum in Germany. The events in Japan are expected to shrink GDP for the first half of calendar year 2011. However, during the second half of calendar 2011, we expect, reconstruction effort should ultimately boost growth. While there will be an impact on the global supply chains, it may represent an increase in demand for alternate sources. For Kennametal, we are getting a number of requests from customers across all geographies including Asia, so there could be an increase in near-term demand, as well as participation in longer-term rebuilding projects. Moving to the outlook for end markets. In transportation, the Japan disaster is impacting global automotive supply environments. Kennametal does not have a significant penetration of Japanese OEMs and that limits are direct exposure. However, we are beginning to see an impact to European and North American OEMs and suppliers. Currently this is limited to the electronics and paint colors, which affects model contents rather than production of power train and drive line components. Also, there may be a high impact to the tier suppliers that rely more on Japanese high-technology inputs, which may affect production in this area. However, this shortage from Japanese suppliers can be offset by Western sources such as Kennametal. In general engineering, global Metalworking activity has increased significantly, although still below prerecession levels. New orders for machinery continue to grow as exports play a large role in demand growth. Capital expenditure programs are expected to continue in order to meet customer needs to increase productivity and efficiency. According to the Association of Manufacturing Technology, consumption has increased significantly from prior year. Going forward, it is expected that transportation and aerospace markets will continue to increase capital spending over the next several years. In aerospace, several programs are poised to start production over the next 2 to 3 years for prototypes, certification and testing. It is expected that production activity will increase when the Boeing 787 enters commercial service and deliveries are ramping up. And Airbus, the A320 have been launched with 332 commitments in a few months. And expect it to reach 500 orders by the Paris Air Show in June. The Earthworks commodities pricing such as coal remains strong. Large mining companies continue to consolidate and invest in capacity, which supports strong demands. Road construction demand trends vary by geography. Infrastructure maintenance levels are governed by availability of funding in developing economies such as North American, Europe. Outlook for China, India and Latin America road construction activity remains upbeat. In energy, oil prices, coupled with tight natural gas shortage have continued to maintain a high level of activity. In North America, the drilling for oil versus gas has shifted from a 20-80 mix to approximately 50-50. Offshore demand for in ramp [ph] and shale products also continue to grow. The process industries continue to show improvement and OEMs have ordered books filled already for the coming 18 months. Specific to our company initiatives, we continue to make solid progress on our video strategy for further increase our market preference in distribution channels. By aligning certain brands under the video name, we have built an outstanding product portfolio, improved customer access to those products worldwide and created a robust distribution brand. We are continuing to top break those who represent our brands. On a year-over-year basis, sales for video products increased by approximately 45% from prior year. Our team is successfully executing this strategy and gaining momentum globally. The overall favorable customer sentiment has been apparent in major industry meetings and events. For example, Kennametal recently participated in CONEXPO in Las Vegas and highlighted our most recent innovations in construction products. At this event we launched several new products including our new razor, Road Razor ECO road rehabilitation tool in line. This is an international exposition held every 3 years to showcase the latest equipment for the construction industries. This year, the event attracted an approximately 2,400 exhibitors and 120,000 registered attendees. Thousands of customers visited our Kennametal booth and although the outlook varies by state, the commentary was generally optimistic regarding the upcoming construction season. At another occasion, Kennametal participated in China International Machine Tool Show held in Beijing a couple of weeks ago. The CIMT, was a successful event with representation from 30 countries and approximately 10,000 attendees. The Kennametal display featured our new product innovation: Beyond Blast and other products from ours spring innovations catalog. Separately, our video booth featured its featured portfolio and sub-brands. Many customer meetings were held and outlook for the region continues to support an expanding economy while balancing inflation risks. During the quarter, we continue to implement price increases across the global customer base. Additionally, we recently notified customers that we will be adjusting our list price on a variety of products. Those increases are necessary in an environment of rising raw material costs, particularly tungsten. We expect that raw material cost increases will continue to affect margins for another 1 to 2 quarters. In the meantime, we will continue to focus in maintaining margin discipline as always. Kennametal customers include some of the world's largest companies and they view our products as valuable to their business and often as critical to their manufacturing processes. Ultimately, we believe that our price increases will be successfully implemented and at a pace that is factored in historically. In addition we continue to work toward completing our restructuring initiatives. At the beginning of the quarter, there were four facility closures in process. Since then, three of the four manufacturing plants have closed and the final facility is expected to be completed in the June quarter. Currently we are realizing approximately $165 million in permanent cost savings at an annualized basis. When restructuring is complete, we will have to do some manufacturing footprint by facilities 20 including divestitures. However, we have retained much of our capacity using our lean processes to share production to existing plants. Today Kennametal has a manufacturing capacity to support up to $3 billion in sales with no significant capital investments. Over all, we continue to reach high profitability and return levels due to our continued focus on operating efficiencies. As evidence of this, adjusted operating margin for the March quarter was slightly higher than 15% and adjusted return on invested capital was approximately 13%, which are all-time record highs. Another metric to consider is incremental margin. For the year-to-date fiscal 2011 period, incremental margin was 42%. This is well in line with our expectation of realizing 40% incremental margin over the cycle, especially when we consider the impact of raw material cost headwind, those accomplishments are impressive. I would like to recognize and thank Kennametal employees for their dedication and commitment to continue to implement our margin expansion goals. I will now turn the call over to Frank so we can discuss our financial results for the quarter in greater detail. Frank?

Thank you, Carlos. I'll provide some comments on our performance for the March quarter and then I'll move on to our update outlook for the remainder of the fiscal 2011 period. So my comments exclude special items, so please refer to the reconciliation schedules that we provided in our earnings release and related to Form 8-K. So let me start off by summarizing the quarter. We continue to make good progress by executing our strategies as Carlos articulated, our organic sales growth was very good coming in at 25% on top of tougher comparables. We once again have strong operating results and we further strengthened our financial position. And we set a March quarter record for earnings per share of $0.83 and an all-time record for adjusted operating margin of 15.2% and return on invested capital of 12.9%. And we achieved our fourth consecutive quarterly record for operating income. I'm pleased with our overall performance especially in light of input cost pressures in the implementation of a new SAP system at the start of the quarter. Now let me walk you through the key items of our income statement. Turning to sales. Our sales for the quarter increased 25% to $615 million, compared to $493 million in the March quarter last year. Our sales growth was achieved despite stronger comparisons of double-digit organic growth of 11% in the prior-year quarter. This represents the fifth consecutive quarter of year-over-year organic sales growth. We also continue to make progress of a better balancing of our business globally. At the end of the March quarter, 54% of our sales were generated outside of North America with Western Europe at 28% and the rest of the world at 26% of sales. Now let me call your attention to the recent events in Libya and Japan and how they may affect Kennametal. As Carlos stated, both situations are unfortunate and devastating and our best wishes go to all individuals affected. The situation in Libya has had very limited direct impact on our business or customers, except for the impact of higher oil prices, which we'll continue to evaluate. In Japan, the usual [indiscernible] supply chain is affected from shipping delays and raw material shortages. Again this has had a very limited impact on our business in the March quarter. We will continue to monitor the situation in Japan as the potential global implications for our business. As many of you know we do not have a large presence with the Japanese automotive OEMs. We're focused on our American and European transportation OEMs and the possible impact on production schedules due to availability of components. One item to point out is that we are receiving inquiries globally including Asia from end users and distributors who are faced with training tool supplier constraints from their existing sources. Some examples include an automotive OEM production line, that was at risk of stoppage and requested immediate replacement tools and vary manufacturer that's testing our products after receiving notification of supply interruption. Additionally, distributors are seeking alternate supply sources to mitigate their risks in general, the typical distributor carries approximately a few months of inventory so we anticipate some increased demand in the near future. From a longer-term view, it is anticipated that Earthworks tools will be needed for rebuilding affected areas after earthquake and the tsunami cleanup. Now, I'll turn to the business segment sales performance. The Industrial segment sales increased 28% from the prior-year quarter, and that was driven by organic growth of 29%, 1% favorable for foreign currency effects, partly offset by 2% impact due to a fewer business days. And our organic basis sales increased in all served markets, led again by strong growth in general engineering and transportation with increases of 34 % and 29%, respectively. Aerospace and defense also grew slightly up 6% compared to the prior year. And regionally sales increased approximately 32% in Asia, 29% in Europe and 23% in the Americas. The transportation in general engineering markets continue to demonstrate the strongest growth. Globally, these markets performed well including the strengthening of business in Europe. [Audio Gap] I'll pick up on discussion of sales on the infrastructure segment discussion. As I've started our infrastructure segment sales increased 19% from the prior-year quarter driven by organic growth, the organic increase was driven by 21% higher sales of energy and related products, as well as a 17% increase in demand for Earthworks products. And regionally organic sales increased 20% in the Americas and 15% in Asia, and 11% in Europe. The energy business continued to benefit from higher commodity prices, increased capital spending, including higher North America and international breakouts. And the natural gas in storage is 2% above the 5-year average. Our Earthworks business had a very good quarter and is currently getting ready for the construction season. As Carlos mentioned, the feedback from CONEXPO show in Las Vegas last month was very healthy. Coal prices are stable, and up from last quarter slightly as are coal stock prices. Now I'll hit briefly our operating performance. Our reported gross profit margin was 37.4%, an improvement of 290 basis points above the 34.5% reported in the prior-year March quarter. The improvement in our gross profit margin was a direct result of higher sales and price realization, increased capacity utilization, higher restructuring benefits and ongoing cost discipline. Not surprisingly, raw material cost is particularly constant, had an unfavorable impact on margin and leverage performance during the quarter. This was once again due to faster than anticipated increase in input cost. So to try to put this in perspective, during the quarter we experienced much improved price realization compared to the December quarter as a result of previously announced price actions in October and January. However, raw material costs further increased faster than anybody anticipated. And had our initial assumptions come true, we would have recovered over 100% of these costs. The fact that tungsten average market price in the December quarter was approximately $300 per metric ton unit and has continued to increase to its current level of more than $400 per metric ton unit. Accordingly, we will manage this challenge effectively with further price increases to recoup these costs. Bottom line, we know the challenge, we're addressing it, and we're still delivering strong leverage. Our operating expense increased year-over-year by 15% or $18 million to $138 million. The primary drivers of the increase in operating expenses were employment costs, including higher incentive compensations due to better operating performance. OpEx as a percent of sales is 22.5% for the quarter, now 180 basis points from the prior year percentage of 24.3%. Our operating income increased to $88 million compared to $26 million of the prior-year quarter. Absent restructuring and related charges in both periods, our operating income was $93 million compared with $49 million for the prior-year quarter. We levered well again this quarter with strong incremental margin at 36.2%, and if you put that on a constant currency basis, we have an additional leverage benefit that would have come in at 37.3%. Our adjusted operating margin reached an all-time record of 15.2% as Carlos said, despite all the headwinds we had to address. We are overall pleased with the performance. Looking at the business segment performance. The industrial segment operating income was $54 million compared with $11 million in the same quarter of last year. Absent restructuring related charges in both periods, industrial's operating income was $56 million compared with $26 million in the prior year. The primary drivers of the increase in operating income are higher sales volume, including price realization, improved capacity utilization and incremental restructuring benefits. This is partly offset by higher raw material costs and the restoration of temporary cost measures from the prior year. Industrials adjusted operating margin increased substantially from the prior-year quarter to 14.3% from 8.6% last year. The infrastructure segment operating income was $36 million compared with $19 million in the same quarter last year. Absent charges in both periods, Infrastructure's operating income was $37 million compared with $26 million in the prior-year quarter. The operating income improved primarily due to higher sales also with price realization, increased capacity utilization and incremental restructuring benefits also offset, in part, by higher raw material costs and the restoration of temporary cost reductions. And Infrastructure's adjusted operating margin increased from the prior-year quarter to 16.5% from 13.8% of last year. Turning to the tax rate, our effective tax rate for the quarter was 19.1% and this was better than anticipated. The improvement in the rate was a result of higher benefits associated with our pan-European business model driven by stronger European earnings. We now expect the full tax share rate to be about approximately 22%. And then regarding our bottom line performance, our reported third quarter fiscal 2011 diluted earnings per share was $0.77 compared to the prior year diluted share of $0.12. On an adjusted basis we came in a $0.83 compared to the prior-year quarter adjusted earnings of $0.39. Turning to the balance sheet, our cash position increased to $184 million and remained focused and diligent on our receivable collection. Our DSOs and IPOs are relatively flat in the March quarter compared to last quarter. At the end of the quarter, our total debt was $317 million which is also flat from last quarter. Our debt-to-cap ratio for the March quarter was 16.9% compared to 20.2% at June 30. Furthermore, our U.S. pension benefit plans remained over 100% funded and our adjusted return on invested capital increased to 12.9%, up significantly from 6.4% in the June quarter. And as I said earlier our adjusted return on invested capital is an all-time company record. Now, let me update everybody on our current outlook. First, we expect economic conditions including global industrial productions will remain positive. We expect our annual organic sales growth rates to be approximately 24% to 25%, which is higher than our previous guidance. This is in line with our goal of growing at least 2 times the rate of increase in the global industrial production. We still anticipate that sales volumes and capacity utilization including restructuring benefits will yield strong incremental margins more than offset year-over-year cost increases for merit and pension and incentive compensation. Raw material costs have increased faster than anticipated. However, we continue to initiate price increases to offset these higher cost increases. As Carlos said, our restructuring benefits are in line to reach $165 million annual savings. And our effective tax rate has improved due to an improved mix business and as I said earlier, we now anticipate a tax rate of 22%. Under these assumptions we expect earnings per share for fiscal 2011 to be in a range of $2.75 to $2.85 per share excluding charges related to previously announced restructuring and related programs. It's a help putting [ph] our revised earnings-per-share guidance into perspective, you should compare this year's expected full-year results to our prior year, record-setting year in fiscal 2008. If you take the midpoint of our current guidance and compare to our earnings-per-share of fiscal 2008, as prior peak of $2.76, you will clearly see that we have higher earnings on significantly lower sales. As a reminder, in fiscal 2008, we had sales of $2.6 million and an earnings per share of $2.76. The projected results for fiscal 2011 clearly show that our cost structure has been dramatically reduced and our strategies are working. The increased guidance reflects record operating margin performance even on sales volumes that has not yet reached prior peak levels. We are well within reach of our next milestone targets. We also anticipate cash flow from operating activities of approximately $255 million to $265 million for 2011. Based on CapEx of $80 million, we expect to generate between $175 million to $185 million of free operating cash flow for the full fiscal year. This is slightly lower than our prior-quarter guidance of $180 million to $200 million and the primary reason is due to slightly higher working capital based on higher sales and higher inventory levels related to recent cost increases. At this time, I'd like to turn it back over to Carlos for some closing comments.

Thank you, Frank. As we move forward, with the key [ph] to build on our enterprise approach. We have transformed Kennametal to become a market trading organization, aligning our business with our serve end markets. This provides customers with the access to our entire product portfolio, facilitate top line growth through cross-selling opportunities and streamlines our costs by improving supply chain and manufacturing efficiency. We are positioned to focus more on customers, gain market share and further increase our profitability. Based on expectations of continued global growth and our ability to maintain strong operating leverage, we have, again, increased our guidance for fiscal year 2011. Our updated organic sales guidance of 24% to 25% for the year, demonstrates that Kennametal continues to outperform the forecasted industrial production rates. Our revised EPS guidance in the range of $2.75 to $2.85 per share compared with the previous range of $2.50 to $2.65 per share, represents an increase of about 9% at the midpoint. This increased guidance reflects record operating margin performers, even our sales volumes that have not yet reached the prior peak levels. During the recent cycle -- during the current cycle, we expect to achieve higher profitability and price deteriors [ph] due to the structural improvements to our cost phase. We continue to be committed to realizing 40% incremental margins for the cycle. In summary, we have strengthened our financial position and enhanced our liquidity. We expect to continue generating strong cash flow. Our global team remains focused on our next milestone target of 15% EBIT margin and 15% return on investment capital. We believe that we can achieve those goals. And, at the end, even further a longer path to premier. Enabled by our long-term strategies, we believe our performers validate our ability to achieve a sustainable level of profitability in the high-teens range. For the past several years, we have taken the necessary actions to further strengthen our foundation and extend our profitability. We continue to balance our several end [ph] markets, business mix and geographic levers. Kennametal is a breakaway company that has demonstrated its ability to be profitable throughout the cycle. We will maximize our strong financial position to meet those targets and deliver continued shareholder value. Thank you for your time and your interest in Kennametal and we will now take care of your questions.

[Operator Instructions] Your first question comes from Eli Lustgarten from Longbow securities.

Just some clarification. Tax rate, you said, this year is 22%, is that what we assume for next year also? Or we thought, I mean, it's sort of an important issue that has been...

Well, I can't obviously get into next year's, we'll provide that in July. But yes, the 22%, is kind of what we anticipate, as you saw the mix between rest of the world and Europe. Europe was a little bit stronger. And as that continues to perform, we should see a deterioration in tax rate or a reduction in tax rate, I should say. As you know, last quarter we guided 24%, we picked up 2 points as result of strong the performance on the second half.

Okay. One of the other things that was a surprise in numbers is the absence of currency in infrastructure, and almost minimal currency versus what we are seeing around at other companies in industrial. Is currency a bigger factor in the fourth quarter for you at this point? You gave us the year, but we are looking currency benefits in the quarter?

Yes. Eli, each of the first three quarters, currency was actually negative. I think it was a couple pennies negative in the quarter, both transaction and translation. And the fourth quarter is actually the first time, and I'm speaking primarily from Europe perspective, but we'll actually have a slight benefit in the fourth quarter. So you're exactly correct.

And the same thing from a number of workdays. I mean, there was a factor that we had a couple of less workdays in this quarter, we get them back in the fourth quarter?

No. Compared to last year, the workdays are essentially the same in the fourth quarter on a year-over-year basis.

And if we talk about the profitability of industrial which seems to be lagging. I mean, it's a big gain versus last year and that's a decent incremental margin or so, but we're still running in the less than 14% kind of number where, 14.3% I guess number, in a business that I guess was expecting to get well over 15% at some point. Can you talk about what's going on in the cost price there? And can we expect to break 15% in the fourth quarter and is that a reasonable goal for an average for the year near-term?

Yes, I think that the performance has been pretty good from a little shy of 12% in the first quarter and we went little bit above 12% in the second quarter. We saw a nice increase of almost 2 points or 200 basis points of improvement in the industrial operating income percent so and we like the improvement. Yes, there is some timing issues with the cost -- input cost in the pricing and there's probably -- we implemented a new system here so hopefully, we can catch up a couple of things here in the fourth quarter. So to have that type of performance, on top of some of the raw material headwinds, putting in a new SAP system at the end of the quarter, I'm actually extremely pleased with the performance of industrial and I think we're moving in the right direction.

As a company, I mean, we are achieving all-time records and this is one of the reasons we have 2 segments. And we look at the segments, sometimes one will perform -- one quarter performs better than the other. But more than likely about 15% EBIT margin.

And it's still reasonable to expect Industrials to get around [ph] 15% as a goal at this point?

That's the goal.

Have prices gone up enough with the way you start to run price increases that you essentially recover all of your costs in the next couple of quarters? You sort of hinted that was the case, but with the new round coming at this point, do you expect to be there by the end of the next 2 quarters?

All right. Yes, as we wrap up the fourth quarter, again, based upon where raw materials is, it's like trying to catch a falling knife sometimes with this tungsten, the way it's been behaving here, but we should be able to recover 100% of our costs in the fourth quarter.

All right.

Your next question is from Andy Casey with Wells Fargo Securities.

Thanks. First, on the third quarter corporate expense, a pretty detailed question but if I'm doing the math right, after adjusting for restructuring, it looked like it came down a couple of million in Q3 from Q2. First, is that math correct and then if so, what drove the sequential decrease and how sustainable is that?

Yes. I would imagine that the third and fourth quarter will be similar. It's just watching expense some of the some of the, I'll call it the SAP implementation costs, we implemented in the January conference. So those costs are trending down as we have as anticipated so yes, at this point I would say that the fourth quarter should be very similar. But your numbers are correct.

Okay, thanks. And then, I'm at another detail on the remainder of the year, this 22% for the full year, is that a net number or does that exclude the restructuring?

That's an all-end [ph] number.

Okay. All right. Thank you very much.

Your next question is from Henry Kirn with UBS.

You've taken out $165 million in fixed costs, you're closing the final 4 facilities. How do you think of the footprint going forward? Is there still any opportunity to do further rationalization and take out even more fixed cost or are we sort of at that the steady state where things are as good as they can be on that level?

Henry, we believe there is always opportunity, I mean, we have a very strong lean culture so every year, we take cost out. The $165 million obviously was singled out at -- because it was a big number and the required special charges. Our anticipation is that in 2011 we go back to the pre-recession where every year we have what sometimes is a significant cost reductions to lean savings. So there are more opportunities and we'll continue to look at those. Everything hinges around how much growth we expect. Is it below 10% or more than 10% but typically what we see right now is to roll into pay-as-you go type of profits.

And could you give a little bit of an updated view on your priorities for the balance sheet and what you're seeing in the M&A market right now?

Yes. I think that we -- the M&A market is good. I mean, we have a strong pipeline. We are very engaged in looking at opportunities. But again, we are very, very disciplined about our M&A process and it's hard to forecast M&A activities. So we can be very optimistic about it and we are ready and have the right balance sheets to take advantage of our good opportunities.

Thanks a lot.

Your next question is from Adam Uhlman with Cleveland research.

Just talk about the Europe business seems to be holding up a bit better than expected. Could you get us a little bit more granular on the market dynamics there?

Yes. I mean, our strength in Europe is because of our mix being filtered into the German market. And as I have been saying for the last few quarters, I think we've been able to outperform the overall European GDP or IPI as a result of our mix. I mean, Germany continues to outperform every country in Europe and the East driven primarily by general engineering and automotive and is driven primarily by exports. And actually their machine tools business is trying to come back. So and they have strong exports into China and India and to, in certain cases, the Latin America. So we feel very good of, I think, the future if we used to be good, and that helps us not only in the top line, but as we can as we from the results of the quarter, that helps us with the tax rate as well.

Okay, got it. And then regarding the commentary around the Japanese quake and the order pick up that you folks have seen or quoting activity -- I guess, how sticky would that business be if you were to win over some business that was supplied by Japanese manufacturers previously?

You know it's really hard to forecast that I mean, we just -- we're seeing that the quoting activity going up. We've seen some of the very little of the buy ex [ph] because I mean, this has only been pretty vague in this as you from Frank, that the distributors -- that's primarily a distribution type of business. The distributors typically carry about 2 months inventory so if you see when we're under of that to occur versus where we are today of about two months old, we anticipate to know more in the next month or so. More details.

Yes. Great. Thanks.

Your next question is from Ann Duignan with JP Morgan. Ann Duignan - JP Morgan Chase & Co: Can I just ask you about your balance sheet performance? Inventories and day sales outstanding were a little bit higher than last year and last quarter. Can you just talk, was that related to SAP implementation or you just give us some color on what's going on there?

Yes. There's obviously some growing pains there and obviously, the sales are a bit higher on the receivable side but we probably -- we'll try to pick that up here in the fourth quarter that's why we didn't change the casual guidance. But as you go through just kind of learning the applications, and you would expect that anytime, that you implement a new system as well. And now, if you look at the inventory on a year-over-year basis, you don't have the cash flow there. Probably up $17 million, the terms [ph] have been flat but we expect at the start to move in the right direction as production teams get also use to the system. Ann Duignan - JP Morgan Chase & Co: Okay, that's a good color. And then Carlos, maybe been a little facetious when I ask this question, but I can totally appreciate Brazil versus Latrobe. But can you just describe the purpose of hosting the Board meeting in Brazil and what are your objectives, your business objectives in Brazil?

I mean we have a practice of taking the board through one of our facilities and have the Board meeting in one of our facilities every year and it's basically in this period. And what we do -- and we take an international maybe every third year. What we do is we take them to places where we had made major investments and/or acquisitions after a couple of years so that they can really see sort of how the investments of the company used, is deployed and sort of understand the market and then get to see the benefits of investing. And that took place here, so we brought the board here and we had a very, very successful visit. And Brazil for us, actually, has the highest growth rate of all of our geographies. Not by a book by much. So this has been very a good investment for us. As I've said, we've been here since 1999 so we're kind of a little bit of late-comer into this -- [indiscernible] -- but we built a new plant here and we actually did an acquisition here so we are really leveraging those benefits right now. I don't know if that answer your question. Ann Duignan - JP Morgan Chase & Co: Okay, yes. No, that's help to add the color, because I was thinking maybe a large acquisition is coming down the pipeline or something. So that's helpful to the understand the context. And just one real final one, Carlos. It's looking like you might you just have given the rate of recovery in revenues and earnings but there is a potential that $3 billion revenue target could be achieved sooner rather than later. To what point do you start thinking about having to reinvest in the businesses, to reinvest in capacity expansion et cetera and could that put pressure on your 15% ROIC target?

Yes. I think that -- I mean, you said it perfectly, we have talked about this $3 billion target. Clearly it's going to come earlier. I mean, it's already an indication based on our performance [indiscernible] that we will get so far, that we had in the third quarter looking at the fourth quarter. And basically, capital takes about, to deploy effectively, it takes about 12 months okay? So you will not put the pressure on the returns of the capital because you're going to have to build capacity gradually. And the trick, when we talk about $3 billion, it's not like we have certain product lines. We would not be at 90%, we'll close to 90% in all products. We will probably at 90% in certain products, where we have to then expand those product lines but certainly, I would not anticipate at this point, to have a major investment even to go beyond $3 billion. I mean I feel very comfortable that we can stay around the depreciation for a while longer. Ann Duignan - JP Morgan Chase & Co: Okay, excellent. I'll get back in queue. Thanks so much.

Your next question is from Walt Liptak with Barrington.

Thanks. I wanted to ask you about the tungsten prices coming up and just get some more clarity on it. You said that, it goes in your commentary, it will be fourth quarter and first quarter, the next two quarters, where you get the cost recovery. But then you mentioned, I think Frank mentioned, 100% cost recovery in the fourth. Can you explain the difference?

Yes. Again, I think the point there is we were a little bit behind here because the raw material costs increase and now, we're going to cover 100% in the course for the full year. We're obviously still behind and we're still going to be chasing that a little bit in the first quarter of next year. But hopefully, with the increases, if they do take a little time, we should get back on track by the first half of the next year but my comp were just 100% of costs increases by the end of fourth quarter.

And do you take out prices already for the fourth quarter?

Yes, they've been announced.

Okay. In Both in North America and Europe or just at?

All around the world, globally.

Okay. And what about tungsten supply? Do you access to supplies, is supply tight?

No. We at -- from Kennametal perspective, we have not had any shortage for type neon [ph] for supplies. It has been the price.

Okay and you mentioned the earthquake in Japan causing issues for some of your competitors. Is that in your guidance that you'd might pick up some share in the fourth quarter and next year because of that?

No. I mean we, just don't have enough detail with it. We don't change our sales forecast based on quarterly activity only. Well, we certainly are putting...

Okay. In the full-year guidance, did you use the adjusted EPS number to $0.83?

Yes.

Okay. Okay, thanks very much.

Thank you.

There are no further questions at this time.

This concludes our discussion. Please contact me, Quynh McGuire at (724) 539-6559, for any follow-up question. Thank you for joining us and have a nice day.