Kennametal Inc. (KMT) Q4 2011 Earnings Report, Transcript and Summary

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 and Fiscal Year 2011 Earnings Call. [Operator Instructions] I would now like to turn the call over to Ms. Quynh McGuire, director of Investor Relations.

Thank you, Regina. Welcome, everyone. Thank you for joining us to review Kennametal's Fourth Quarter and Fiscal Year 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 practice in prior quarterly conference calls, we've invited various members of the media to listen to this call. It's also being broadcast live on our website, and a recording of this call will be available on our site for replay through August 29, 2011. I'm Quynh McGuire, Director of Investor Relations for Kennametal. Joining me for our call today are Chairman, President and Chief Executive Officer, Carlos Cardoso; Vice President and Chief Financial Officer, Frank Simpkins; and Vice President Finance and Corporate Controller, Martha Bailey. Carlos and Frank will provide further explanation on the quarter's financial performance. After their remarks, we'll be happy to answer questions. At this time, I'd like to direct your attention to our forward-looking disclosure statement. The discussion we'll have today contains comments that may constitute forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve a number of assumptions, risks and uncertainties that could cause the company's actual results, performance or achievements to differ materially from those expressed in or implied by such forward-looking statements. Additional information regarding these risk factors and uncertainties is detailed in Kennametal's filings with the Securities and Exchange Commission. In addition, Kennametal has provided the SEC with a Form 10-K, a copy of which is currently available on our website. This enables us to discuss non-GAAP financial measures during this call in accordance with SEC Regulation G. This 8-K presents GAAP financial measures that we believe are most directly comparable to those non-GAAP financial measures, and it provides a reconciliation of those measures as well. I will now turn the call over to Carlos.

Thank you, Quynh. Good morning, everyone. Thank you for joining us today. I'm pleased to report that Kennametal again achieved strong results for the June quarter of fiscal 2011. During the quarter, we had organic sales growth of 24% year-over-year. This growth was realized on top of 39% organic growth in the prior year period. In addition, we achieved all-time records on an adjusted basis with operating margin of 17.5% and earnings per share of $1.11 for the June quarter, as well as return on invested capital of 14.8%. For fiscal year 2011, Kennametal has also delivered historical highs for operating margin, earnings and return on invested capital, even with sales that are lower than the prior peak. Incremental margin for the year was 39%. This validates our ability to capitalize on top line growth as well as the permanent nature of our streamlined cost structure to achieve higher levels of profitability. We are proud of these impressive results because they demonstrate the progress of Kennametal's transformation. The effectiveness of our initiatives, the ability of our global team to execute our strategies and above all, our capacity to deliver our promise of premier performance. During the quarter, Industrial production continued to show favorable trends in markets such as general engineering, transportation, earthworks and energy. Our order rates were strong, reflecting ongoing customer demand on a global basis with emerging markets continue to lead the growth. For the June quarter, Kennametal's Rest of the World market represented 27% of sales and grew 36% from prior year quarter. We continue to implement our WIDIA brand strategy. For fiscal year 2011, WIDIA Product stills increased 37% year-over-year, reflecting strong growth. As evidenced by our recently announced agreement with Fastenal to be the WIDIA's national distributor in North America, there will be additional opportunities to expand our presence in distribution channels and gain further market share. As we mentioned in prior discussions, price increases are being implemented to recover high raw material cost as necessary, specifically tungsten. Our customers continue to value our products and recognize Kennametal's contribution to improving the productivity of their manufacturing processes. We continue to increase prices as needed and we'll maintain margin discipline. During this June quarter, we successfully completed our restructuring initiatives, which included reducing our manufacturing footprint by 22 facilities in total, including divestitures. However, we retained much of our operating capacity by shifting production to existing facilities by using lean principles. The restructuring program resulted in a higher than expected annual cost savings of $170 million. This represents fixed cost that have been permanently removed. The aggressive streamlining of our business combined with disciplined portfolio management have generated significantly higher operating margin, earnings and return on invested capital. From a macro perspective, economic activity in the manufacturing sector continues to expand. According to IHS Global Insight, another soft patch is occurring but a double dip is not expected. The world's economic expansion is forecasted to gain momentum in the second half of calendar year 2011. Major downside risks facing global economy are uncertainties of our fiscal austerity and sovereign debt. Upside opportunities include stronger spending by consumers and business in U.S., Northern Europe and Asia. Thanks to improved balance sheets. Let's discuss the outlook in our served end markets. In aerospace, an increase in production is anticipated in commercial aviation. At the recent Paris Airshow, Airbus surpassed its own previous record at 713 intentions of purchase during this event. Last week, American Airlines announced it just placed the largest order in aircraft in aviation history, and intends to add 460 narrow body, fuel-efficient models. The implications on the supply chain are positive, as both Boeing and Airbus are ramping production of their flagship products. In general engineering, new orders for industrial machinery are expected to continue to grow. Traditional manufacturers have increased the investment spending domestically and internationally, focused on productivity and efficiency to help offset labor costs. In transportation, light vehicle sales are forecasted to be more than 12 million units in U.S. according to IHS Global Insight. In addition, it is expected that supply disruptions related to the Japan disaster should ease, and sales will reach nearly 16 million units by 2013. On a global basis, light vehicle output is expected to be more than 76 million units in 2011 and grow to approximately 87 million units in 2012. Going forward, there may be additional growth opportunities related to the light-weightening of cars, with an introduction of carbon fiber reinforced polymer into the body structure. In earthworks, commodities pricing remained strong, a record high mining capacity expansion investment continues. Central Appalachia's steam coal and met coal pricing remain strong. China and India's sea-borne coal demand continues to increase, along with Japan in the wake of the spring's nuclear disaster. Regarding road construction, demand trends to vary by geography. In developed economies of North America and Western Europe, infrastructure maintenance levels are governed by ability of funding. Overall, funding outlook in developed economies is worsening due to the fiscal tightening and austerity measures. However, in emerging markets such as China, India and Latin America, the construction activity is upbeat. In energy, North American inventory is just below the 5-year average. A warmer than expected summer may cause an uptick in seasonal demands. However, high gas prices may continue and are expected to keep prices at relatively the same level to calendar year 2011. By the end of calendar 2011, the Energy Information Administration forecasts that marketed natural gas production will increase and continue into calendar 2012. Overall, Kennametal continues to achieve higher operating margin, earnings and return levels due to our strong focus on operating efficiencies. As a result, adjusted operating margin for June quarter reached 17.5% with adjusted EPS of $1.11, and adjusted return on invested capital was 14.8%, which all are all-time records. In addition, I would like to mention that Kennametal received national recognition for our commitment to excellence. For example, we were recently awarded Delphi's 2010 Pinnacle Award for Supplier Excellence. The WIDIA Products Group was honored with the ISA's American Eagle Value-Added Partner Award for showing exceptional documented cost savings of productivity improvements to an end user. This accomplishments are remarkable, and I'd like to recognize and thank Kennametal employees for their dedication and commitment. I will now turn the call over to Frank, and he will discuss our financial results for the quarter in greater detail. Frank?

Thank you, Carlos. I'll provide some comments on our performance for the June quarter, and then I'll move on to our fiscal '12 guidance for the next fiscal year. Some of my comments exclude special items, so please refer to the reconciliation schedules that we provided in our earnings release in the related Form 8-K. So let me start by summarizing the June quarter and in part, the year. So, Carlos, I'm pleased to report that for both the June quarter and the full fiscal year, we set records for operating income, earnings per share and return on invested capital. In the June quarter, we again delivered strong organic growth coming in at 24% versus tougher comparables last year. We also had stronger operating results and our capital structure continued to strengthen. Our restructuring programs have been successfully completed and have yielded higher benefits and lower cost to execute than previously anticipated. I also want to point out that for the full fiscal year, we achieved these records while encountering the implementation of a new enterprise structure July 1 of last year. We upgraded our ERP system on January 3. We dealt with higher raw materials and the effects of salary and benefit restorations, including higher incentive compensation. So a great year on many fronts. Now let me walk you through the key items in our income statement, starting with sales. Our sales for the quarter increased $155 million or 29% to $694 million. This compares to $539 million in the June quarter last year, and this was due to 24% organic growth or 6% favorable foreign currency impact and that was partially offset by the effects of fewer business days. Our sales growth was achieved despite stronger comparisons of double-digit organic growth of 39% in the prior year. And this represented the sixth consecutive quarter of year-over-year organic sales growth. As Carlos alluded to, we also continue to further balance our business globally. And for the June quarter, approximately 55% of our sales were generated outside of North America, with Western Europe at 28% and the Rest of the World at 27%. Now looking at the business segment sales performance. Our Industrial segment sales of $437 million increased 31% from last year. This was driven by organic growth of 25% and a 7% favorable foreign currency impact, partly offset by 1% unfavorable impact due to fewer business days. And on an organic basis, sales increased in all served markets, led by strong growth in general engineering and transportation with increases of 33% and 19%, respectively. Aerospace & defense also grew. That was up 8% compared to the prior year quarter. And regionally, our sales increased by 32% in Asia, 24% in Europe and 20% in the Americas. As Carlos pointed out, the transportation and general engineering markets continued to demonstrate the strongest growth. Globally, these markets performed well, including the strengthening of business in Europe and continued growth in Asia and the Americas. Our Infrastructure segment sales of $257 million increased 26% from the prior-year quarter, driven by organic growth of 22% and a 4% favorable foreign currency impact. The organic increase was driven by a 24% increase in demand for earthwork products and 20% higher sales of energy in related products. Regionally, organic sales increased 29% in Asia, 23% in the Americas and 13% in Europe. Our earthworks business had a very good quarter given the construction season and mining activity. Pricing for Central Appalachia's steam coal is trading at approximately 20% higher year-over-year, and met coal continues to trade around the benchmark of $315 a ton with support planned mining activity. And in the energy market, the U.S. and international rig counts are higher than the prior year by 21% and 3% respectively, and the Canadian rig count is up 6% year-over-year, and natural gas and storage remains at 2.5% below the 5-year average. Now I'll touch on our operating performance. Our reported gross profit margin increased 130 basis points to 38.3%. This compares with 37% in the June 2010 quarter. Our strong gross profit margin was a direct result of higher sales and price realization, increased capacity utilization, higher restructuring benefits and continued cost discipline. Not surprisingly, raw material cost, particularly tungsten, had an impact on our margin and leverage performance during the quarter. Our operating expenses increased year-over-year by 16% or about $20 million to $143 million. The primary drivers of the increase in operating expenses were employment cost, including higher incentive compensation due to better operating performance. Our operating expense as a percentage of sales was 20.6% for the quarter, down 230 basis points from the prior-year percentage of 22.9%. I'd like to take a moment to summarize our restructuring program which is now completed, and as Carlos said, ended with favorable results. As you know we embarked on this initiative a few years ago to help improve our cost structure and our competitiveness. So the final figures for the restructuring program resulted in total charges of approximately $150 million. And more importantly, annual benefits are expected to slightly exceed approximately $170 million, and the combined footprint reduction including divestitures was 22 total facilities. Our operating income increased to $115 million. This compares to $61 million for the prior-year quarter. Absent restructuring and related charges in both periods, our operating income was $121 million compared with $74 million in the prior-year quarter. We levered well again this quarter with a strong incremental margin of 30%, and on a constant currency basis, our leverage was even higher at 34%. Our adjusted operating margin reached an all-time record of 17.5% despite all of the headwinds we had to address. And I'm very pleased with the operating margin performance. Looking at how the business segments operating performance happened. The Industrial segment operating income was $77 million compared with $32 million for the same quarter of last year. Industrial's operating margin increased substantially from the prior year to 18.7% from 12.8% last year. And absent restructuring and related charges in both periods, the Industrial operating income was $82 million compared with $43 million in the prior-year quarter. And the primary driver is the increase in operating income with a higher sales volumes, price realization, improved capacity, utilization and incremental restructuring benefits. This was partly offset by higher raw material costs. The Infrastructure segment operating income was $38 million, and this compares with $31 million in same quarter the prior year. Infrastructure's adjusted operating margin was 15.6% in the current quarter. Absent restructuring and related charges recorded in both periods, Infrastructure's operating income was $40 million in the current quarter compared with $34 million in the prior-year quarter. Operating income improved due to higher sales volume and price realization, increased capacity utilization, higher restructuring benefits but offset by higher raw material costs. Regarding our overall bottom line performance, the reported fourth quarter fiscal 2011 diluted earnings per share were $1.04, and this compares to the prior-year diluted earnings per share of $0.49. And then on adjusted basis, our diluted earnings per share were $1.11 compared to the prior-year adjusted earnings of $0.61 a share. Again, this adjusted earnings per share of $1.11 is an all-time record. And to put this into perspective, we earned more earnings per share in the June quarter than we did all of fiscal 2010. Our balance sheet remained strong and we improved our financial flexibility. Our cash position increased to $205 million and remained focused on improving our working capital. Looking at some of the metrics, our DSO and IPO were flat in the June quarter compared to last quarter in the March period. However, we made further progress with our days payables, which increased 4 days from March to June. At June 30, our total debt was $313 million, a decrease of approximately $4 million from the March quarter. And our debt to capital ratio at June 30 was 15.9% compared to 20.2% at June 30, 2010. I'd like to point out that our senior unsecured notes are not reflected as current liabilities in our balance sheet, and we are in the process of reviewing financing alternatives and I'll cover that in a second. Furthermore, our U.S. defined benefit pension plan remained over 100% funded. Our adjusted return on invested capital increased to 14.8%, up significantly from 12.9% in the March quarter. And as I previously mentioned, our adjusted return on invested capital is an all-time company record. Now let me turn to the outlook. Our outlook for fiscal '12 assumes that the global economy and worldwide industrial production will continue to reflect moderate expansion and that the overall economic trends will remain in positive territory. As a result, we expect to experience positive growth in all our geographies. The following are some additional assumptions encompassed in our outlook. Global industrial production is anticipated to be in the mid-single digits for the full fiscal year. Sales volumes and related capacity utilization are expected to yield favorable incremental margins and offset year-over-year cost increases. Our net interest expense will increase in fiscal '12 by approximately $8 million. This is largely due to the need to refinance the $300 million of the 7.2% 2002 notes that will mature in June of 2012. Our expectation is to approach the public market this fall to take advantage of attractive market rates. Proceeds from the new debt transaction can be used to call the existing bonds or be retained on the balance sheet to repay the notes at maturity before other general corporate purposes. Our effective tax rate is projected to be around 23% for fiscal '12 and that's based on our anticipated global earnings mix. And our earnings are expected to be consistent with our historical seasonal patterns with approximately 40% of earnings occurring in the first half and 60% in the second half. Taking these factors into consideration, we expect organic sales growth to be 10%, 12% higher than fiscal 2011, and total sales growth to be higher by 9% and 11%. This is in line with our goal of growing at least 2x the rate of increase in global industrial production. We also expect earnings per share for fiscal 2012 to be in the range of $3.50 to $3.80, and the midpoint of this range represents a 22% increase from fiscal 2011 adjusted earnings per share of $2.98. In addition, fiscal 2012 guidance reflects our expectation of achieving our next milestone target. And that's for you who know us. That's 15% earnings before interest and taxes or EBIT margin, and 15% return on invested capital. And this is one year earlier than previously anticipated. Our cash flow from operating activity is expected to be in the range of approximately $360 million to $380 million for fiscal '12. Based on anticipated capital expenditures of approximately $100 million, the company expects to generate between $260 million to $280 million of free operating cash flow for the full fiscal year. At this time, I'd like to turn it back to Carlos for some closing comments.

Thank you, Frank. Going forward, we'll maintain our strong commitment to executing our strategies. We will further balance our served-in [ph] certain markets, business mix and geographic presence. We expect to continue generating strong cash flows and will remain disciplined regarding our capital allocation process. We'll keep driving our ongoing transformation to be an even more customer-focused enterprise and continue to deliver premier performance. As evidenced by the June quarter and fiscal year 2011 results, Kennametal continues to realize higher operating margins, earnings and return on invested capital. We achieved all-time record highs even with sales are even lower than prior peak levels. For fiscal year 2012, our guidance reflects expectations of continued global growth and our ability to outperform industrial production. Our fiscal 2011 EPS guidance in the range of $3.50 to $3.80 per share represents a 22% increase from fiscal 2011 adjusted EPS of $2.98 per share at the midpoint. In summary, our global team remains focused on achieving the next milestone target of 15% EBIT margin and 15% return on invested capital in fiscal year 2012, a year earlier than previously anticipated. Our long-term strategies remain consistent. We will advance even further along the path to premier by maximizing our strong financial position and deliver continued shareholder value. Thank you for your time and your interest in Kennametal. We will now take questions. Thank you.

[Operator Instructions] Our first question comes from the line of Adam Uhlman with Cleveland Research.

I was just wondering if we could talk about the infrastructure margins a little bit? It seems like the material cost have crept back up there. Can you maybe go through the dynamics of the quarter? And then also your outlook for material costs for fiscal '12?

Adam, I'll start. Yes, and I think you hit on it right there as we said on our prepared remarks. And raw materials continued to increase throughout the quarter. And I know you guys follow the APT trends. So they went up a little bit quicker than we had originally planned. Good news is it seems like they have somewhat taken a pause here for a while. So while the pricing was trying to catch up with the raw material cost, they rose a little bit faster than we had anticipated. But we should be able to get that back as we get into the new fiscal year. So our outlook is to get that nothing better than our guidance going forward into fiscal '12.

Okay, I got it. And then, Frank, on the guidance for the year, it looks like you're going to be better than even the 15% goal, if my math is correct, closer to 16%. And I just wanted to check to see if that's correct. And then secondly, if when we said expect some new long-term margin targets given that you have a loan 3 years a year early?

Again, Adam, I think directionally your math is correct. You're spot on, from that perspective given where we're at. And as far as the next milestone, we're not ready to talk about it yet. I think we need to deliver the goal of 15 by 15. As I said in New York, no later than '13 which we're going to do next year. Once we accomplish that, we'll revisit and set the next milestone after that.

Yes, this is Carlos. This is subject, most likely, we're going to discuss at our September meeting.

Our next question comes from the line of Eli Lustgarten with Longbow Securities.

A couple of quick questions. Just for clarification, corporate expense turned out to be $500,000 in the quarter again, I guess. Can you give us an idea what's going on? And what that number would look like for next year?

Yes, nothing unusual. And again we're trying to -- we will look at whether we had a little bit of a benefit last quarter that didn't come through this quarter. But we're winding down some of our initiatives from last year that's why it tailed down in the second half. And, Eli, I would tell you this next year, it will probably, if I had to take a stab at it, it will be about $10 million for the year. So roughly $2.5 million a quarter. If you look at it, so I would -- it's basically going to be flat.

So your margins, I mean, start touching but you got much better expected margin industrially, you probably did somewhat disappointing margins in infrastructure, turned out both for the year about the same. Can we -- what would be a more normalized rate for industrial next year? I guess I can't believe it's going to stay at 18.7% and will we get those kind of margins in infrastructure next year which is sort a more norm?

As far -- we're going to continue to do well. I think some of the restructuring benefits, most of the benefits were on the industrial side as opposed to the infrastructure. So we're going to continue to watch the discipline. We've got some key initiatives and some new products on the industrial side. Particularly, we like the relationship with the Fastenal arrangement, so that's going to help us there. So we think -- we don't expect much deterioration at all from that perspective. And then I think we should see a little bit of a benefit on the infrastructure side as we catch up with the price increases and the raw materials.

Now you're referring to the deterioration from the year number? Or the fourth quarter number?

From the fourth quarter.

So you expect you can keep the margins in the high teens industrially for early next year on a seasonal basis?

Absolutely. And, Eli, I'll remind you that the cycles of the 2 business are different. So you'll see a time where the infrastructure margins are higher than the industrial. And typically in the recovery, the industrial margins are better.

And, Frank, can you talk about the debt refinancing that you're doing? You said higher charges of $8 million, yet unless something really changes, you're going to save a couple of hundred basis points on the debt refinancing. So that $8 million all front-loaded in the first quarter, first and second quarter because of the course of finance, I mean, it's hard to believe it's going to go up except for court charges associated because your cost will be lower on the same day?

Yes, you're exactly correct. We will definitely be able to refinance the 7.2 notes much lower than where it's at today. So the strategy really, and the numbers actually, the higher interest expense works out whether we do want them to approach as whether we do the May pole tender. And then you could have a higher charge in one quarter, and then you have much lower earnings. So you got some seasonality that will skew the seasonality a little bit. Or we issue it in the fall and we keep the cash on the balance sheet and repay it back in June of 2012. Now we're going to have the higher carrying costs associated with the debts. We're looking at a couple of different ways and what's more advantageous, we'll look at it in the fall.

But should we spread the higher $8 million? The $8 million is $2 million a quarter effectively, over the 4 quarters or front-loaded in the first half? I mean...

Yes, I would assume that we would most likely try to do it in the second quarter.

So basically, the $8 million goes in one quarter and the second quarter? Is that what you're saying? Or?

No. There's 2 different scenarios. It depends on what we do. So you can either spread it if we do the ladder scenario that I'd talked about. If we would do the May pole, you would probably have more in the second quarter and less in the second half.

Okay. It's something like that. One final question. One of the benefits in cutting through -- I mean, the Japanese tragedy also affected the #4 to #7 suppliers in cutting tools globally. Did you see much benefit of that? Or are you hearing much from customers wanting to make sure they had supplies, and give me some share? And will that sustain itself?

Yes, Eli, this is Carlos. I mean, it's really hard to quantify because most of that would have come from WIDIA replacement. And as you said earlier, WIDIA for the year grew at 37%. So clearly, we have replaced some of those Japanese suppliers. And -- but we can't quantify. I would say they would most likely keep the majority of it.

Our next question comes from the line of Holden Lewis with BB&T. Holden Lewis - BB&T Capital Markets: Are you able to give a sense, I mean, you've had a number of price increases both sort of big broad once as well as maybe more targeted smaller ones. And then I think that they, sort of, can concentrate towards the back half of '11. When you're talking about your revenue growth rates, what are we assuming for price in that? And, I guess, I'm curious on what you achieved in '11, and if that carries forward, you'd get a full year, what that sort of implies about '12?

Yes, I mean, I'll talk from '12 and Frank can fill in on the '11. But we typically plan for a 1% to 2% price increase as we start the year. All I can tell you that it is higher this year for 2012. And, obviously, we're not going to get into very specific details for competitive reasons. Frank, '11?

Yes. Again, I think we've -- Holden, we don't want to necessarily give out, as you know we do reflect prices in our organic growth rate. But to Carlos' point, it was above our typical average in the fourth quarter. And that's all I'll comment on at this point. But the raw material costs increase a lot faster. And I know what you're trying to get at, but at this point, I'm not comfortable with the price given that assumption out of -- given the competition dynamics. Holden Lewis - BB&T Capital Markets: Okay. So fair enough. But on the price cost dynamic, than looking at the 2 blended. I think your thoughts were where tungsten was before, that you'd sort of be behind on the margin in the second half of this just done fiscal year. And then you'd be sort of at or above parity on the margin in the first half of fiscal '12. Given what tungsten's done in your pricing actions, do you still feel like you've sort of got back to neutral by the time you get into this Q1 period? Or is tungsten pushed to behind that a bit?

We're close to that. Let me just say it that way.

And by year end, we'll be ahead, if everything stays the same, obviously. Holden Lewis - BB&T Capital Markets: Okay. So things pushed in right a little bit. And then last thing, working capital, looks like your inventory and receivables led up to fair bit, any commentary on that?

We finished with the strongest month of the year on the receivables side. So very strong finish on the sales. And then we had to buy some additional raw materials at higher prices. So temporarily, a little bit higher on the inventory side. But I like the progress that our purchasing and treasury team have done with the payables. So where -- we had a nice plan to get that back in the line. So that will continue to increase as we go into next year, and then to really focus in on the receivables and particularly, or I should say more importantly, our inventory turns as we go forward.

Our next question comes from the line of Julian Mitchell with Crédit Suisse. Sheila Kahyaoglu - Crédit Suisse AG: This is actually Sheila on behalf of Julian. A few questions for you, on the incremental margins, I know it was discussed that they were about 30% in the quarter. I assume some of that was because of FX, was such a big tailwind for the topline. So a bit of a headwind on the margin. On fiscal '12, that should accelerate. But your guidance implies 30% at the low end, 37% at the high end, so the midpoint is accelerating from the Q4 level, is that correct?

Yes. To start with your first point there, the difference between the -- of constant currency and actual which is 32%, point out and 34%, if you put on a constant currency basis. Currency, when we look at that for the year, I'll just use one currency to give you some kind of guidance. We finished this year, the average euro as we do it was about $1.36. When you do your plan right, we assumed $1.37 for the full year, and now it's a little bit higher. So you don't obviously lever at all or very little bit on the incremental margin. So the way we did our plan, FX shouldn't have a significant impact given that the euro's our biggest currency. And we're looking at around the constant currency basis, the $1.36 to $1.37. I don't think at this point the way we did the plan and the guidance is going to have a significant impact. But if the currencies get out of line, we'll update at the end of every quarter, as we typically do. Sheila Kahyaoglu - Crédit Suisse AG: And also any change on order trends or demand trends from June to July? Can you comment on that?

Outside of seasonality, the orders are consistent with our guidance. We feel good about it. Sheila Kahyaoglu - Crédit Suisse AG: And last question, on just a quick one. Aerospace and Defense grew 8% in the June quarter. Commentary around the Paris Air Show suggest that they should pick up as commercial aerospace accelerates in fiscal '12? Do you think that's accurate to assume?

Yes, absolutely. I mean, the orders by the time we ship, take a little longer in the aerospace market. But we feel very good. And our aerospace business is starting to do very well.

Yes. The only thing that I would add to that is we had our best quarter in aerospace in the June quarter. And that trend's up from March. So you can extrapolate that.

Your next question comes from the line of Ann Duignan with JPMorgan. Ingrid Aja - JP Morgan Chase & Co: It's Ingrid. I'm just standing in for Ann. I'm wondering if we could circle back to WIDIA. What kind of growth expectation is in your guidance for WIDIA this year? And I guess, what percent of that growth is driven by Fastenal building its inventory?

Well, I mean, we are not going to publish how much our growth is expected obviously for competitive reasons. But we expect WIDIA to continue to outpace all the areas in our business. And the Fastenal is again really hard to predict. As a matter fact, this week, we have probably 100, close to 170 people here getting training for -- from Fastenal. So it's really hard to predict. Our assumptions right now is the growth is going to be small. But we'll see how it goes through the year. So it's very difficult to predict at this point.

So, Ingrid, again , that's -- the couple of comments there, we like the growth opportunities particularly with Fastenal driving that in the Americas. And I also like the opportunities we have in Asia. So there's -- these are -- this is really starting to gain some traction on all geographies. Ingrid Aja - JP Morgan Chase & Co: Okay, great. That's helpful. And then just going back to the price increases and offsetting the cost. Are you still expecting the 40% incremental operating margin target through the cycle? Or is there expectation around that changed at all?

I think we took that into consideration with our guidance here, if you look over the past 3 years. We think we're pretty much in that because the prior year was very strong, we've finished the year right around 40% this year. And as some of the calls earlier, somebody commented between 30 to mid-30s. So that puts us right where we committed to previously.

Yes. And I would expect that by mid-year, again according to our guidance, we are at a run rate of the peak. So peak sales in the past. So I would say that if you really look at and calculate that, our 40% incremental margin through the cycle, I believe we're going to meet or exceed that.

Your next question comes from the line of Walter Liptak with Barrington Research.

I wanted to ask about the seasonality. And, Frank, I think you commented normal seasonality, 40%-60%. Looking back at this year, there were some issues early in the year with the EPS coming in at, I think, 34% in the first half. And I guess, what are the puts and takes here? Pricing is probably in better shape than it was last year. But we're -- it looks like some of the industrial regions are starting to slow a little bit. Should we be cautious on the first half?

I think we're a little bit more -- we look at -- your right, Walt, the driver's obviously, it'll be what price does, what industrial production does on a global basis. That's how we kind of look at it. And like anything else, we put a stake in the ground at the end of the year. We look, historically, how it's been. We kind of rolled up. I'm not going to try to get it too precise here, plus or minus on the 40 and same thing with the 60, it could move a little bit higher, it can move a little bit lower. Depending on how at the second half of the calendar year. But as you would expect, fiscal '12, or the second half of our fiscal year's in calendar '12. So as we get a little bit more visibility we'll update it as we go forward. But that's our best estimate at this point.

Well, industrial production for IPI for FY '11 was 5.9. Current forecast for FY '12 is 5.2. So it's going to go down from 5.9 to 5.2. My point is, though, I'll be really happy with 5.2 and 13% growth, 11% to 13% growth on top line.

Would you expect that like in the first, second quarter that we're going to have equal quarters, like 20 and 20? Or do you think the first quarter will, because of holidays and things like that will be weaker than the second?

If you take into consideration the debt, I think, the second quarter would be a little bit less because of higher interest expense. But on the surface, not exactly 20-20. But the second quarter's on a normal basis, is a little bit stronger than the first.

Our next question comes from the line of Andy Casey with Wells Fargo Securities.

A couple of questions. First on free cash flow guidance. At the midpoint of your fiscal '12 guidance, you're expecting free cash flow as a percent of net income to be about roughly 90%. That's up pretty strongly from this year's performance, not adjusting for the restructuring. What is changing to achieve that given you're looking for higher CapEx?

Well, I think the inventory growth was the main driver in the prior year. Andy, I don't we need -- we won't need increase as much on the inventory side as we did in the past year. So that was a, I don't want to call it drag, but kind of, growth with the working capital on fiscal '11 versus '12.

We also did some strategic buys on the raw material because the raw material increased quite a bit. So you had demand coming in. And the growth in this 2012 as a percentage of growth is going to be lower. So we've built the inventory to support FY '12 growth. And we did some strategic buys on the raw material.

Andy, I would add to your point on the CapEx which is up year-over-year. That's really pretty fast, it's kind of -- it's emerging, I'll call it market expansion in Asia. In a couple of areas, the support for some new products that we have here, that you and the guys all know about Beyond Blast. And to further drive increased profitability, we also put some equipment into productivity.

Okay, thank you for that. Then if I can turn back on the prior demand questions, clearly I'm sure you've seen other companies have talked about seeing demand soften in some regions. You're really diversified and have above market growth prospects. But I'm wondering if you're seeing any underlying market demand trend weakening recently in any region?

Well, I mean, I think that I go back to the IPI, I mean, we're going from a 5.9 to a 5.2. So there is what I would consider a little bit of a deceleration. But is again, included and implied in our guidance. And we really haven't seen any weakness in any particular market at this point.

Your next question comes from the line of Henry Kim with UBS.

I wonder if you could talk a little bit about the mix shift from direct to indirect as we go through fiscal '12? Where do you expect to be as we exit fiscal '12 versus where we are today?

Well, I mean, I think that we believe that we're going to continue to grow. Or we will grow the indirect faster than that direct. So I haven't actually looked at from a percentage, we typically say that we're about 60%-40%. I'm not sure what the impact in the overall percentage is. So our growth in 2011, the indirect, grew at a much higher pace than the company as a whole. And I believe that it's going to be the same case this year, 2012.

Is there a margin impact from that, on the operating margin level?

No. If it's anything, it's positive at the operating margin.

And one final one, if I could, could you walk through your latest thoughts on M&A?

I mean, we have a healthy pipeline. And we are always in discussions with the number of companies. But as you know, forecasting something is very, very difficult. So we are open and would do an acquisition that would make sense. And we're always in talks with some companies.

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

As you've gone through some of the sensitivity analysis on your, kind of, forward look, if you think about a slow to medium growth industrial production environment given your cost structure and how your operating now, do you think your EPS growth rate on a normalized basis settles in at high teens, a low 20% over time? So nothing about '12, just on a go-forward basis?

Yes. Absolutely. I mean, we always talked about 15% being sort of our next milestone. We also talked about that we believe this business is the mid to high-teens EBIT margin business.

No. I'm talking about earnings growth rate.

Yes. The same.

Same thing? Okay. And thinking about the overall goal of growing 2x global industrial production, when you put together the current growth forecast, can you tell us what the implied growth rate is in developing markets versus developed? And then how you see that kind of shaking out over the year?

I'll give you a, I mean, a point of reference that again it goes back to the IPI. The Asia Pacific area has an IPI of 8.7 versus NAFTA at 4.1 and versus the European union at 2.7. So the developing economies are going to grow at a significantly higher pace than the developed economies. That's going to continue.

So you look at that higher growth rate in the developed economies, and I know market share can be hard to gauge in some of those markets. Do you have share gain targets? And can you measure that versus just what the cycle gives you?

No. I mean it's really hard especially in developing economies because the data is just not there. But my view is that if we are growing in 2-3x the IPI market, I mean we have to be getting some market share, right?

Yes, that's the reason.

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

Most of my questions have been answered. I guess given the out-performance on the cost save at $170 million for the plant closures, has that changed any way how you're approaching your thought process? I know you stated in the past that you'd go back to the more normal restructuring to the course of the cycle as demand comes through? But given the out-performance here, does that change how you look at it at all?

No, I mean, I think that we're at least from what we see for the 2012 guidance and where we see the growth to be is that we would not do any called out [ph]restructure. If you look at it that way, I mean, we are constantly looking at our cost and adjusting our cost accordingly. But the difference between the previous estimate and what we came out is 2 additional plants. And I think at this point, we feel very that we are sized properly for our going forward projections.

So I guess stepping back from just 2012, but longer-term. You guys had historically closed one to 2 plants or rationalized facilities, whatever euphemism you want to use. Is that a pace that we should expect to be accelerating, given the success of this program?

Well, I mean, I wouldn't -- at this point, there's a lot of, as I can sense in the call. And the economy, there's a lot of share around there. So we will probably not going to do that much this year. And I think going forward, our view is if we continue to have the growth that we think we're going to have, we'll go back to doing something like that going forward. We want to do that, but we would not accelerate that. And I continue to remind everybody that's not a lot of square footage is just typically our very small plants that have fixed costs that we can eliminate by moving, I mean, to one of the larger facilities.

No, absolutely, yes, the rationalization makes complete sense.

Your next question comes from the line of Holden Lewis with BB&T. Holden Lewis - BB&T Capital Markets: A couple of things as it relates to sort of profitability going forward. First, with regards to where you feel you're sized to. I think in the past, you've talked about really not having to make any investment to support growth until you're about a $3 billion kind of business again. Can you comment on that? And then secondly, the SAP system that you rolled out, I guess, you're tweaking that through the March period, or what have you. You should have about a quarter now of really trying to run it and get the benefits and advantages out of it. Can you talk a little bit about what you're doing with that and what the expected benefits and contributions should be from that?

Yes, I mean, I'll talk about the SAP isn't really now 6 months. We kicked it off in January 3. And I think some of the benefits are already into the $170 million that we talked about. So going forward, I think we're going to have a better understanding of our customers. We're going to have a better understanding of our markets in market share as well as some of our specific cost. I think the visibility is very good. And so we haven't really quantified any additional savings. I mean again, our margin continues to expand, therefore the benefits are one of the drivers for the expansion of the margin is cost savings are coming from the SAP and how we run the business. Relative to the $3 billion is we're still looking at that. That is we don't have to make any major investments in our infrastructure to get there. And again, our capital is in line around the depreciation, so we plan to continue in that pace. Holden Lewis - BB&T Capital Markets: And on the SAP things, I mean, you're not sort of attributing, we think just broadly 50 basis points of annual improvement related to things that stem from the system. There's no way to sort of quantify or put a range around with that benefit of farming that could be?

No. I mean our first priority with SAP, and the changing of the organization, was that we're going to make sure that $170 million were fixed, permanent, cost take-out and they wouldn't be coming back. So we did things like, we integrated all the payables into one area. And receivables and so forth. So all of that, majority of that was part of the $170 million cost take-out. Now what we're going to get forward is the SAP is going to get help us with growth. Because it's going to help us to be more focused and so forth and understand our customers better.

And this concludes our Q&A period. Ms. McGuire, do you have any further remarks?

Yes, this concludes our discussion today. Please contact me, Quynh McGuire, at (724) 539-6559 for any follow-up questions. Thanks for joining us.