Kennametal Inc. (KMT) Q2 2012 Earnings Report, Transcript and Summary

Good morning. I would like to welcome everyone to Kennametal's Second Quarter and Fiscal Year 2012 Earnings Conference Call. [Operator Instructions] At this time, I would like to turn the conference over to Quynh McGuire, Director of Investor Relations. Ma'am, you may begin your conference.

Thank you, Nicole. Welcome, everyone. I'm Quynh McGuire, Director of Investor Relations for Kennametal. Thank you for joining us to review Kennametal's second quarter of fiscal 2012 results. We issued a 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 in 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 February 26, 2012. 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 achievement to differ materially from those expressed in or implied by such forward-looking statements. Additional information regarding these risk factors and uncertainties is detailed in Kennametal's filings with the Securities and Exchange Commission. In addition, Kennametal has provided the SEC with a Form 8-K, a copy of which is currently available on our website. This enables us to discuss non-GAAP financial measures during this call in accordance with SEC Regulation G. This 8-K presents GAAP financial measures, that we believe are most directly comparable to those non-GAAP financial measures, and it provides a reconciliation of those measures as well. I'll now turn the call over to Carlos.

Thank you, Quynh. Good morning, everyone. Thank you for joining us today. I am pleased to report that for the December quarter of fiscal 2012, Kennametal, once again, delivered strong results. For the period, organic sales grew by 14% year-over-year. This growth rate reflects strong customer demands and it is impressive, giving strong comparisons of 31% from the prior year quarter. In other key performance metrics for the December quarter, Kennametal's operating margin reached 14.7% with earnings per share of $0.91. Both of those represented December quarter records for the company. Due to continued focus on operational excellence, our profitability reflected strong year-over-year incremental margin of 36%. In addition, adjusted return on the invested capital was 17.3%, which is an all-time company record. Our top line growth for this fiscal year has been as we expected, and it is trending consistently with the fiscal 2012 guidance of 10% to 12% organic growth on a year-over-year basis. We continue to believe that manufacturing is leading the economic recovery currently underway. In addition, our results were attributable to our global team's successful execution of our proven strategies to outperform industrial production and improve our market position. For the December quarter, global industrial production increased by 2.1%, indicating that expansion is still occurring in a number of end markets. Along with the positive macroeconomic, Kennametal -- environment, Kennametal clearly benefited from our own growth strategies and initiatives, which resulted in 14% of organic sales growth for the quarter. For the 6-month period ending December 31, industrial production growth was 1.1% while Kennametal realized 16% organic sales growth for the first half of our fiscal year 2012. Customer demand in industrial markets continue to show strength, particularly in general engineering, aerospace and transportation. Infrastructure markets, such as energy and mining, also reported steady growth, and we expect them to expand further, as we move through the economic cycle. We also saw increased activity across many of our served geographies, with the emerging markets continue to show the fastest growth. Currently, our rest of the world markets represent 27% of total sales during the December quarter. During the period, we continued to implement our channel brand strategy. For the first half of fiscal 2012, WIDIA product sales increased 27% year-over-year, reflecting ongoing strength. We'll continue to maximize opportunities to expand our presence in distribution channels and gain market share. Let's now discuss end market trends. In general engineering, customers continue to increase efficiencies in order to lower labor costs. This should allow capital expenditure programs to grow even through -- even though there are some uncertainties related to U.S. tax and regulatory policy. Overall, the metalworking machinery industry has performed well, due to general rise in industrial activity globally, particularly in the U.S. We expect this trend to continue for the next several quarters. In transportation, sales in the global light vehicle market are anticipated to grow to 103.7 million units. Key markets that will outperform the global average includes South America, China and South Asia. According to a November 2011 report issued by IHS Global Insight, worldwide light vehicle sales are higher by 3.6% compared with the prior year, despite production and distribution -- disruption problems related to the Thailand flooding. IHS forecasts, global light vehicle production is expected to grow by 6% in 2012 to reach 81.1 million units, boosted specifically by the recoveries in Japan, Korea and Southeast Asia. In aerospace, the industry is looking for high productivity improvement and innovation. Commercial airlines are expected to add more planes to their fleets to provide an opportunity to increase future revenues and address high fuel prices. For example, Southwest Airlines, recently announced its order for 2008 of the redesigned and more fuel-efficient version of the Boeing's most popular plane, the 737 model. Our portfolio offers products for titanium and superalloy machining and other products that support the development of advanced manufacturing processes. In the mining market, metallurgical coal prices have stabilized in recent weeks, but the overall outlook for 2012 is for further price decline, driven by softening steel demand, resulting from eurozone weaknesses, uncertain U.S. demand and slower growth in BRIC economies. However, the impact of further price softening is not expected to change the investment strategies for major mining firms as 2011 was a record year for mining activity and capacity expansion. In highway construction, activity in eurozone and U.S. is forecasted to decline due to government austerity measures and funding issues. However, shipments for construction machinery through October 2011 increased significantly, with order backlogs and new orders also increasing. In energy, the U.S. Energy Information Administration or EAI (sic) [EIA] expects consumption of natural gas in 2012 to grow in all sectors, particularly in the electric power market. Those trends are expected to continue into 2013. North America natural gas inventories are projected to reach record levels as storage injections are high in November, according to IHS Global Insight. In addition, the usual warm winter weather, combined with domestic production increases during the year, resulted in high storage levels. Because of continued gas production, natural gas prices are expected to remain stable, even with the higher demanding during the winter months. Regarding cost reduction measures, we continue to benefit from savings related to our past restructuring initiatives. We are realizing annualized cost savings of $170 million. Those costs have been permanently removed from our structure. In addition, other initiatives aimed at streamlining our business have both strengthened our foundation and improved our operating excellence. As a result, we are confident that Kennametal can support up to $3 billion in sales without significant additional capital investment. Our stronger enterprise has also made Kennametal a safer place for our employees. In November, we were named, one of America's safest companies by a leading environment health and safety industry publication. Kennametal's margin performance during the quarter reflect our continued ability to recover inflation costs related to tungsten, our primary raw material. We continue to execute appropriate pricing actions and remain -- and maintain our margin disciplines. As always, we continue to successfully execute Kennametal's growth strategies. As announced last week, the pending acquisition of Deloro Stellite reinforces our strategy of acquiring technologies that strengthen our core business. In addition, we are leveraging our enterprise structure to gain additional top line growth from cross-selling. We are increasing our presence in distribution channels through our WIDIA brand strategy. We are showcasing our capabilities in technology and innovation and improving our customers' productivity through new product introductions. We are expanding our presence in rest of the world markets. As a result, we are further extending our reach to penetrate new markets, grow market share and capture new customers. I will now turn the call over to Frank, who 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 December quarter and then I'll move on to our outlook for the remainder of the fiscal year 2012. Some of my comments are non-GAAP. So please refer to the reconciliation schedules, we provided in our earnings release as well as our related Form 8-K. So let me start off. The December quarter, once again illustrated strong progress towards our goal of achieving 15% EBIT and 15% return on invested capital this year. As we've discussed previously, this is 1 year ahead of schedule. Our December quarter highlights included solid top line growth as evidenced by 14% organic growth, record quarter earnings per share of $0.91 and operating margin of 14.7%, an all-time record adjusted return on invested capital 17.3% and included in the release, you'll the actual amount was 16.6%, so very favorable. Raw material cost continued to stabilize, and our price increases are holding. And as Carlos mentioned, in January, we entered into a definitive agreement to acquire Deloro Stellite that will strengthen our core business. Now let me walk you through the key items in the income statement. Sales for the quarter increased $76 million or 13% to $642 million and this compared to $566 million in the December quarter last year, and that's due to 14% organic growth, offset by the effect of less business days. Our sales growth was achieved despite stronger comparisons of double-digit organic growth of 31% in the prior year quarter, and this represents the eighth consecutive quarter of year-over-year organic sales growth. We also continue to benefit from an improved balance of our business globally. For the December quarter, 55% of our sales were generated outside of North America, with Western Europe at 28% and the rest of the world at 27% of sales. Turning to the business segments' performance. The industrial segment sales of $410 million increased 11% from the prior year quarter. This was driven by organic growth. On an organic basis, sales increased in all served markets, led by strong growth in aerospace and defense of 16%, general engineering of 12%, and a 7% increase in transportation. Regionally, sales increased by approximately 15% in the Americas, 13% in Europe and 1% in Asia. As many of you know, the growth we experienced in the prior year December quarter was exceptional and strong across all regions, especially in the emerging markets. For comparison purposes, last year, Asia grew 48%, Europe was up 34% and the Americas grew 31%. Our infrastructure segment sales of $232 million increased 18% from the prior year quarter, driven by organic growth of 19%, offset by the effect of less business days. The organic increase was driven by 25% higher sales of energy and related products and 15% increase in demand for earthworks products. Regionally, organic sales increased 34% in Asia, 16% in the Americas and 10% in Europe. The infrastructure business also had very strong prior year growth, with sales of 24% in Asia, 21% in Americas and 12% in Europe. Now a recap of our operating performance. Our reported gross profit margin increased 70 basis points to 36.1%, compared with 35.4% in the December 2010 quarter. Our gross profit improved due to higher sales volume, price realization, and incremental restructuring benefits. This was partly offset by higher raw material cost. As I noted earlier, while raw material prices have doubled compared to last year, this cost continues to stabilize. We'll continue to watch for developments with these materials. Operating expenses remained relatively flat year-over-year. In fact, our operating expenses increased only 2% or $2 million. We remain focused on controlling general and administrative costs, and making select investments and selling related costs. We are focused on controlling the G&A portion to fund the selling expenses, as we discussed at Analyst Day. Operating expenses as a percent of sales was 21% for the quarter, and this was down 200 basis points from the prior year percentage of 23%. Our operating income increased to $94 million compared to $62 million in the prior year quarter. Absent restructuring and related charges, operating income was $67 million in the prior year quarter. As Carlos has noted, we levered well again, with a strong incremental margin of approximately 36% on both an actual and constant currency basis. Operating margin was a December quarter record of 14.7% and 290 basis points higher than the prior year quarter adjusted operating margin of 11.8%. Looking at the business segments for operating performance. The industrial segment operating income was $63 million compared to $42 million in the same quarter of the prior year. Absent restructuring related charges, industrial operating income was $46 million in the prior year quarter. Industrial operating margin increased 290 basis points to 15.3% from an adjusted operating margin of 12.4% in the prior year quarter. Primary drivers of the increase in operating income were higher sales volume and price realization partly offset by higher raw material cost. The infrastructure segment's operating income was $33 million, and this compares with $22 million in the same quarter of the prior year. Absent restructuring related charges, infrastructure's operating income was $23 million in the prior year quarter. Infrastructure's operating margin increased 260 basis points to 14.4% from an adjusted operating margin of 11.8% in the prior year quarter. Operating income grew primarily due to higher sales volume, price realization despite significantly higher raw material cost. Our effective tax rate for the quarter was 17.3% compared to 21.3% in the prior year quarter. The current year benefited from a $4 million valuation allowance adjustment and from the impact of stronger earnings in our pan-European operations. And regarding our bottom line performance, we reported a December quarter record diluted earnings per share of $0.91 compared to the prior year diluted earnings per share of $0.52. The prior year earnings per share included restructuring related charges of about $0.10. Turning to cash flow. Our cash flow from operating activities was $71 million compared with $67 million in the prior year. Net capital expenditures were $33 million year-to-date compared to $14 million in the prior year period. Free operating cash flow for the 6 months ended December 31, 2011 was $38 million compared to $54 million in the prior year period. Subsequently, we had an improved December quarter performance for free operating cash flow compared to the September quarter. Our balance sheet remained strong. Our cash position was $129 million and was up from $103 million in the September quarter. We remain focused on improving our working capital, and DSO and IPO are relatively similar levels in the December quarter compared to the September quarter. However, we made further progress with our days payable, which increased 2 days from September to December. And we also initiated actions to better balance our inventory levels and demand for the second half, as we discussed last quarter. At December 31, 2011, our total debt was $308 million, down $5 million from the June quarter, and our debt-to-capital ratio at December 31, was 15.9%, and that's consistent with the June quarter. We have been monitoring the bond market in anticipation of refinancing our $300 million, 7.2% senior unsecured notes that are due in June of 2012. With the public announcement of the Deloro Stellite acquisition and our upcoming 10-Q filings for the second quarter results, we expect to become more active with respect to the refinancing transaction. When the transaction is executed, we'll use the proceeds for [Audio Gap] debt reduction and general corporate purposes and we expect to retire the June 2012 notes when they become due. Furthermore, our U.S. defined pension -- benefit pension plans remain 100% funded, and our adjusted return on investment capital increased to 17.3%, up significantly from 14.8% in June and, as we mentioned, represents an all-time high. As we announced last week, we signed a definitive agreement to purchase Deloro Stellite from Duke Street Capital for EUR 277 million, as Carlos mentioned. And as a refresher, Deloro Stellite has approximately EUR 220 million in annual sales, 7 facilities, and 1,300 employees. This is in alignment with our growth strategy and positions us to further achieve geographic and end market balance. The transaction is expected to be accretive in earnings in fiscal 2013, and we plan to fund the acquisition through existing credit facilities and operating cash flow and remain committed to our investment grade rating. Regarding share buyback, we were not active during the December quarter due to the ongoing discussions related to the Deloro Stellite transaction. We will continue to be opportunistic in buying our stocks. To date, we have repurchased 3.5 million shares since the program was approved 1 year ago. We have 4.5 million shares outstanding on the existing repurchase authorization. And our priorities to cash remains consistent. We will continue to evaluate share buybacks, acquisitions, dividends and capital expenditures. Now I'll turn to our outlook. As Carlos mentioned, the global economic conditions and industrial production are expected to continue to reflect moderate expansion. And this view is relatively consistent with what we provided at the start of our fiscal year. As such, we have maintained our fiscal 2012 organic sales growth guidance range of 10% to 12%, an increased sales growth guidance to a range of 10% to 12% from the previous estimate of 9% to 11%. Full year foreign currency impacts are now expected to be offset by the impact of more business days in fiscal 2012. We have also increased our earnings per share guidance for fiscal 2012 to the range of $3.70 to $3.90 per share from the previous range of $3.60 to $3.85 per share. Now I'll walk you through the factors of our increased earnings per share guidance from the prior midpoint of $3.72 per share to the new midpoint of $3.80 per share. The factors include: One, the effective tax rate, as a result of the December quarter tax benefit of approximately $4 million, coupled with a slightly lower overall effective tax rate in the second half. We estimate a total positive benefit of approximately $0.08 per share. Second, interest expense. Due to the timing of the bond refinancing, we have concluded it no longer makes sense to offer the Mako [ph] premium, which we originally planned to occur in the December quarter. As a result, we now expect our full year interest expense to be favorable by approximately $0.05 per share. Foreign currency. We anticipate the foreign currencies, and in our case primarily the euro, will become a headwind in the second half of our fiscal year. At the first half of our fiscal year, we benefited from a stronger euro, which averaged about $1.41. For the second half, we expect the euro to weaken this is the first half and average in the high $1.20s. This is anticipated to have an unfavorable impact of approximately $0.03 per share. And lastly, as a result of our plans to improve inventory levels in the second half, we are now expecting an unfavorable impact on our margins of approximately $0.10 per share. However, we will offset a significant portion of this impact through improve productivity and pricing. So on a combined basis, this will have an unfavorable impact of approximately $0.02 per share. Taking all these factors into consideration, they add approximately $0.08 share to the midpoint of our full year earnings per share guidance. And in the closing of the acquisition of Deloro Stellite, which we expect the impact to our earnings per share of fiscal 2012 to be between $0.05 and $0.10 per share unfavorable, which includes transaction cost for approximately $6 million. This impact from the Deloro Stellite acquisition has not been reflected in our current EPS guidance. And cash flow from operations is expected to be in the range of $330 million to $360 million for fiscal 2012. Based on capital expenditures of $100 million, the company expects to generate between $230 million to $260 million of free operating cash flow for the full fiscal year. Now I'd like to turn it back to Carlos for a couple of closing comments.

Thank you, Frank. As we move forward, we are forecasting an environment where demand is expected to grow moderately. However, we can continue to outperform industrial production by maintaining our strategies and growth initiatives. Those growth drivers include enterprise selling, new product introductions, emerging market expansion, pricing actions and our indirect channel strategy. Additionally, the pending acquisition of Deloro Stellite will advance our strategies by further diversifying our customer base, products and end market and geographies. We will also continue our transformation toward becoming a customer-focused enterprise and a market-facing organization that is well positioned to identify new opportunities. We will capitalize on our strong foundation to maximize margins, earnings and returns. Those are the strategies that helped us transform Kennametal into a breakaway company, one that is profitable throughout the economic cycle. Financial flexibility in the current environment continues to be important, and we remain committed to maintaining a strong financial position. As always, we will continually evaluate ways to streamline our cost structure. Our priorities use of cash continue to include reinvesting in our business such as capital expenditures, buying back our stock, increasing our dividends and making acquisitions. We will remain disciplined in our capital allocation process to increase shareholder value. We have repositioned Kennametal to continue delivering improved margins and returns. Our global team remains highly focused on achieving our milestone target of 15% EBIT margin and 15% return on invested capital for fiscal year 2012. Thank you for your time and your interest in Kennametal. We will now take questions.

[Operator Instructions] Your first question comes from the line of Ann Duignan with JPMorgan.

It's Mike Szeliski [ph] filling in for Ann. Just a couple of quick ones for you. I was wondering if you can tell us how much of your infrastructure business has been benefiting from onshore natural gas drilling. I mean, what is your outlook for that particular segment?

The gas drilling is a strong portion of our energy business. So obviously, we have been benefiting from that and we anticipate, that we'll continue to benefit from those activities.

Okay, thanks. Also, on infrastructure, maybe you could just give a little bit more color about the relative strength you saw in Asia in the quarter, just with any particular area, country, business that you saw strength over in Asia.

It's really all around. I mean, again, things change in a quarter-to-quarter basis, as we know. China is focusing on the infrastructure and building more infrastructure to offset summer decline in their industrial sector. So there is really not any one particular area.

The only thing I would add to that is, we did make some capital investments in the prior year, one in China, one in Australia. And I think we're starting to see the benefits of our strategies with the top line.

Great. And then finally, a little bit more color maybe on Europe. I know you had mentioned enough tax headwind, but I was kind of wondering if you think -- it's definitely a headwind. There's something there, but has the organic growth, have plans changed or the petition has changed for Europe?

Actually, I will tell you that Europe this quarter performed slightly better than I -- we anticipated. I will emphasize that every geography for us this quarter grew at double digits. So we continue to see strength in the industrial portion of the market in Europe.

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

A couple of quick questions. One, you indicated tax rate in the second half is going to be lower than the first half. Can you give us -- are we talking about a 21% tax rate in the second half?

Eli, okay -- Eli, as you know, the first quarter was 23%. It's slightly lower. It's probably going to be between 22% and 22.5%. So it's probably almost likely going to be down about 50 basis points from that. And that will get us to the full year a little bit over 21%.

Okay. And the interest charge, you say, because of your change, you're not going to have the premium. Do we expect that interest charges to basically stay about $5 million, $6 million, between $5 million and $5.5 million for the rest of the year, except for the acquisition, I understand that?

Excluding the acquisition now. Because we won't be financing, basically have 2 tranches outstanding. So the interest expense, I would say, it's probably going to be about $28 million for the year. So you're looking at anywhere about $8.5 million in the next 2 quarters.

So there's a big difference between expectations. Then I guess the biggest surprise, if I had to look at the quarter, was the margins in industrial that occurred. When -- in fact, there's strength in the first quarter. And I guess we didn't expect it to fall as much as it did. Can you give us some idea of what should we expect for the rest of the year in the industrial margins? When you're 17 point first then you dropped to 15 plus in the second, should we -- are we looking at blended 16, 16.5 for the rest of the year? Or could you give us some sense of what is happening?

Well, Eli, let me start talking about the top line and then I'll let Frank address the margin in particular. Again, at Analyst Day, we talked about that we have 6 drivers -- 6 of the 7 growth drivers. And this is why we will continue to outproduce the industrial sector. We have 6 drivers that are not controlled, which one of those is the distribution channel. Again, I emphasize, WIDIA grew 27% while the company grew at 14%. So again, we continue to show that we can outpace industrial production and obviously, that volume helps us all around. That's not going to stop this quarter. I mean, we still have a lot of room, because this WIDIA brand is addressing wide space that Kennametal was not playing in before. So this is the reason why we'll continue to outpace industrial production by a significant margin. Frank, do you want to talk about the margins?

Yes. From a margin standpoint, Eli, your question, is industrial going to have a stronger second half for the numbers you mentioned? Yes, we believe so. And I would say Q1 to Q2, it's -- I think the inventory was a little bit too high in my opinion in the first quarter. So we started to ratchet that down in the second quarter. So that volume impact was more pervasive on the industrial side. So that's the driver. Now I think we're going to have a better balance going forward.

And related to that, you talked about bringing inventories down, I guess, in the second half of the year. Is that mostly in industrial?

Yes.

And that's where impact will be? So are we going to hold back profitability based on that?

Well, as I said, obviously, for the full year, we think we'll be okay. You got a little bit of benefit in the first half, but I think we'll be able to offset that with some productivity, and some select pricing that will get in the second half. So it's going to be close.

And then a final question. Can you talk about the margin outlook for infrastructure? We're still, I guess, below where we think the more traditional long-term profitability sector.

Yes, we expect that margin to continue to increase from the second quarter. The second quarter, there is some seasonality factor with the construction period, et cetera. And some of the price increases that we put in, in the second quarter, we expect the third and fourth quarter to be improved.

One final question. The acquisition of Deloro Stellite. You gave us, I guess, a negative impact this year. You sort of indicated -- you might give us some guidance for fiscal '13 of what kind of ballpark incremental accretion might look like. I think what was assumed something of steady at $0.25 this year. Is that an unreasonable number?

Eli, it's Quynh McGuire. We're going to have to defer that, the answer to that question, until July, when we provide guidance for the fiscal year '13. Some of that will, obviously -- could be part of the planning process.

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

I guess, first, was there anything unseasonal in the fourth quarter? Was there any benefit from either a pull forward in advance, the price increases or accelerated depreciation incentives on -- after your customers?

Yes. First of all, let me correct. That was our second quarter. It was calendar year fourth quarter. It's our second quarter. We really don't see -- didn't see anything that was unusual from a pull-in perspective. I mean, a lot of people ask if the Tax Reform Act have any impact on a pull forward. And we typically don't benefit from that. We're selling consumables. So we don't have the big capital-type equipment. So it was pretty much as expected. If anything, we may have -- we probably finished the first quarter a little bit stronger in the month of September, but the quarter progressively -- we got stronger, November and December, to be honest.

I want to emphasize one more time. We gave guidance in June. We are still and we are true to our guidance, halfway through the year. And our new guidance that we just gave is true to the original guidance that we gave in June for 2012. So it shows that our model and forecast is working.

And on the Deloro acquisition. What's been the reaction of the customers so far now you're over a week into it in terms of having that out there. Have you gone to your customers and gotten any sort of initial feedback?

Well, our customers are a little more patient than Wall Street. Our customers realize we haven't called yet, but obviously, the customers were -- our joint customers and our large customers have reacted positively at this point. But again, for regulatory reasons, we have to be very cautious and really wait until we close before we start talking to customers in a more detailed basis.

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

I would -- quick again to the industrial issue, sales growth rate a little bit. That was pretty flat for the quarter whereas the infrastructure business was up a lot, I guess. What's the -- there's a tough comp, obviously, but what's the underlying demand trends looking like there? And how are you thinking about that unfolding over the next couple of quarters?

Yes. I mean, I just want to remind everyone that in the industrial side, the comp was 48% growth. I mean, 48% growth is not going to happen every quarter for the rest of our lives here. But in a quarter-by-quarter basis, as China manipulates the -- or works their GDP between 8% and 10%, there are shifts from infrastructure investment versus industrial investment. And I want to tell you that last year was -- during this period, we had a lot of projects. In other words, a lot of the investment in factories that are today online producing components. So I would anticipate the rest of the year, that China will come back and have a bigger percentage of growth in the industrial side. And in total, it's a great -- I mean, it's a great story, actually. I'll remind everyone, double-digit growth in every geography. I mean, that's one of the reasons why we have this geography balance, sort of the reason why we diversify the business. So that we are in this position. We are going to have 1 market or 1 geography that is performing lower, and we'll have 1 or 2 or 3 balancing that. So that's the whole strategy of our company.

Okay, I got it, great. And then speaking on growth investment, you mentioned that expenses are up only 2% or so and while the investments that we made over the last year are helping drive some pretty good growth like in Asia with the infrastructure business. I'm just wondering conceptually how you're thinking about hiring new sales guys or making other investments to support growth for next year?

Well, I mean, we continue to make those investments. I think that obviously, we are -- as Frank said in his remarks, we are taking away from G&A to put it in the S. So we're offsetting one with the other. So the fact that we did all this restructuring back during the recession, and we did a fixed risk -- fixed cost reduction and part of the variable cost, we are continually looking at offsetting to increase our sales and the front end in investments. And again, I'll remind everyone on the line that we always said that this business has -- is -- we can grow up to $3 billion without the major capital investment as well. So we have some room to go.

Adam, the only thing I would add to that, and I agree with that, is -- I think, we actually have much improved/better visibility to our entire cost structure as a result of SAP, particularly on the SG&A side. It's a way of you have to look at every single department much better than we've ever had in the past. So we continue to find little things. There's no home runs in there, but I think we were talking about this in the past. So we keep getting on base, hitting a single here and there. And over time, they start to add up. So I like the visibility that we have, particularly with the structure.

Your next question comes from the line of Julian Mitchell with Credit Suisse. Julian Mitchell - Crédit Suisse AG, Research Division: I just wanted to follow up really, I guess, on the China point, specifically. We saw yesterday, Rockwell Automation, obviously, seeing sales down slightly in China in the December quarter. And I guess aside from what the government might or might not do in terms of monetary policy, what are your own kind of direct customers and the distributors kind of telling you how they're behaving? Has there been any changed trend in their behavior in recent months? Because I think on your Q1 earnings call, you'd said that when talking to customers and so and there was evidence that maybe you were nearing a trough in short cycle industrial demand. Have you seen sort of more or less evidence of that in the interim?

No. I mean, we continue to feel strong about Asia -- about China. I think that if you look at the forecast at IPI, it continues to be in the 9% to 10% for our Q3 and Q4. So again, very, very difficult comps, specifically the comp for this quarter that we just finished. But we feel all indication -- our customers, our distributors at this point reflects -- or is reflective of our new guidance. Julian Mitchell - Crédit Suisse AG, Research Division: Okay. So I guess your new guidance on sort of sales, what sort of trend does that embed for the Asian industrial business for March and June? I mean, again, there's sort of a flat performance in March and then a pick-up in the June quarter year-on-year. Is that sort of the thrust of it?

We typically don't provide specific growth, colors related to specific -- our businesses are strong. We're trying to gauge right now China. China is just wrapping up the new year. So we'll kind of continue to look on that. But I'll tell you, the second half of our business or the March and June quarter, we typically do better. So we expect the performance to continue as we originally guided. And whether there's puts or takes, that's embedded in our 10% to 12% organic growth. Julian Mitchell - Crédit Suisse AG, Research Division: Okay, great. And then just a follow-up. I guess for the full year, fiscal '12, what do you think kind of the net impact on your earnings from kind of price and input cost dynamics, taking everything together just for the full year as a whole?

Yes, we typically realize 1% to 2% and -- obviously, we don’t go into a lot of specifics, but I can tell you that our pricing is better than that this year.

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

Most of my questions have been answered. The acquisition that you have pending, it seems like it's going to be accretive. I know you can't comment that on for next year. But I'm just wondering, does this put you on kind of a hiatus from working at acquisitions for a period of time, as you integrate this? Or would you still be open to sort of smaller kind of bolt-on acquisitions?

No. I think that we are -- we still have a strong pipeline in the acquisitions. Obviously, it's very difficult to forecast acquisitions, but we continue to be active. And this acquisition, as Frank mentioned earlier, is not only accretive for 2012. We think we're going to be able to pay for that within the -- in '13. And so -- and our balance sheet -- so the debt-to-equity doesn't change that much. So it leaves us -- we have a strong balance sheet. It leaves us a room to make acquisitions further.

Yes. I guess -- maybe I'll clarify that question. Yes, from a balance sheet standpoint, obviously, you have the dry powder that you need. I guess from an operational standpoint, what I'm trying to get my arms around is you guys have made fantastic cuts, cut the cost. But did that leave you with sort of the ability to go -- to handle more than something like this from an operational standpoint?

Yes. I mean, this is -- this acquisition is going to require less integration because it's a new technology. And then an acquisition that would be similar technology, where we have to post plans and so forth. And so this gives us more room, if you want to put it -- more capacity in our organization to handle additional acquisitions.

Brian, what I would add is prior to us taking ownership, they just went through a comprehensive portfolio analysis and restructuring. So they've divested a couple of businesses, that we weren't of interest with and made some rationalizations. So we'll continue to leverage their footprint as well and, as Carlos alluded to, take advantage of back office synergies, purchasing, et cetera, going forward.

Yes, this is a growth play. This is a growth play.

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

Just a couple of questions. As indicated previously, a lot of questions are already asked. But if I could go back to the infrastructure, U.S. domestic exposure, could you kind of walk through what you're seeing in both those nat gas and coal extraction demand? And really, the essence of the question is I just wanted to make sure, I understand the comments that you already made on the 2 markets. Do you expect them to be, when you go forward, kind of above last year or more of a flat to good but flattening trend?

It will be above last year. I mean, I think that will be moderate growth, as we talked about earlier, and we're still excited about the energy. And obviously, as we get this new acquisition that plays a big role in the energy side, we continue to be very optimistic about what we can do.

Okay, thanks. And then again, a clarification. It's the last one for me. You pretty much have been answering a few questions about China. To be clear, are you' expecting demand re-acceleration anywhere else?

I don't fully understand.

Oh, I think in response to an earlier question, sequentially, typically, you see China get better in the second half versus first half.

Correct, yes.

Is there any other region given all the macro news going on that you would expect that to occur? I would have imagined the U.S. side.

Yes. And I think that [Audio Gap] again, I continue to remind everyone that our biggest markets and we continue to see -- the market still continues to be good for us. In Germany, I anticipate it to continue to be. Again, it's still decelerating but a positive growth.

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

I wanted to ask, I guess, a follow on to Eli's question about some of the margins. Or maybe just talk generally about the gross margin, which was a little bit below what I was looking for. Was it the similar situation where you brought down inventory and that's why we saw a little bit lower gross margin?

Yes.

Okay. And just going further down the income statement. Last year, you have the cost out already. In your SG&A, numbers levered really well. Can you talk about -- is there continued cost out that's happening? And I guess, what kind of SG&A can we -- operating expense can we see for the year?

I mean, the first quarter is probably the peak, Walt, from -- on SG&A because we actually have 2 shows both on IMO and imX and then we do our typical grand finale of stock compensation. I would expect it to be 21% for the full year right now, if I had to put a number on it for you, around that figure. Because like I said, we're watching the G&A very closely. We did a lot of the heavy lifting to your point. So we're fine in synergistic opportunities across both businesses and will continue to drive that kind of concept, so that if we have to invest in selective markets, whether it's sales or personnel, that we're able to do it at a reduced cost because we're finding other ways to offset it. And at the heart of everything is we continue to drive the leanest part of our KVBS business model.

Okay, got it. And if we can go back up to the full year gross margin and your comments about the inventory. So we'll continue to see -- my guess is that we'll continue to see some year-over-year pressure on gross margin. Is that right?

The margins will be up in the second half and that's going to be up year-over-year. So let me just put in that perspective.

Okay. And then just the last one, the revenue was a little bit light from the consensus and from my revenue number and you had 15% growth through November. Did the December numbers slow anywhere, I guess, specifically in Europe? How are you getting double-digit growth with your figure, I guess, on recession?

Yes, first of all, Walt, the December did not slow down. And again, we have specific drivers that are controlled by Kennametal. I talked about the WIDIA strategy, the perfect example, again. Let's not forget 27% growth on WIDIA, okay? So that is helping us outperform significantly not only the overall company growth, but obviously the industrial production. The enterprise selling, we talked about. By the way, we continue to have more than 40% of our sales coming from new products. Companies, as things slow down, look for more productivity. They need to address their cost structure. Therefore, they are a lot more open to try new products and so forth, pricing and our continuing expansion in Asia. I mean, we continue to have 27%, 28% of our sales coming from the rest of the world, which Asia is a big portion of that. Those are drivers -- growth drivers that are above and beyond the global economic expansion. So this is why we continue to outperform IPI by a significant factor. And it's not going to change for the second half of the year. We're going to continue to be on this pace.

The other thing, there's actually over 3 less work days from the first quarter. The way the calendar involves us here last year, there was 2 last -- but the market obviously was a lot stronger. This year, there was almost 1.5 days less that changed on a year-over-year basis but over 3 from Q1 to Q2. So that's probably why.

Your next question comes from the line of Joel Tiss with Buckingham Research.

Just a quick clean-up, any updates on pension? We've seen a lot of other companies have to lower their discount rate. I know you're a different fiscal year, so it might be coming. But can you give us any updates on what you're thinking there or what you're seeing?

Yes. I mean, next to your point, we'll start looking at our discount rate assumption, as we get ready for the fiscal '13 guidance. But as I think I made the comment of our pension fund because we implemented the LVI [ph] strategy a few years ago because that proved to be very prudent and we don't foresee any issues for this fiscal year for us. If then we'll get into next year, we'll talk about the puts and takes.

And then any highlights you can give us on incremental restructuring, like what else can you do going forward besides what's already in place? Or are you going to adjust more optimization of what you've already done?

Yes. We are not contemplating any major restructuring at this time. However, I'll remind everyone that we practice leaning this company and we drive cost reductions every year, significant cost reductions. So we're going to continue to do that. And by the way, those cost reductions also free up additional capacity.

Your next question comes from the line of Gregory Macosko with Lord, Abbett. Gregory M. Macosko - Lord, Abbett & Co. LLC: Just a question regarding WIDIA growth. Are the margins the same in that business, just overall relative to the Kennametal brand?

Our EBIT margins are the same. So I mean, we talked -- always talked about the fact that the direct sales has a higher cost to serve. So they have a higher margin. And so that is offset by the higher cost to serve, where indirect product has a lower margin but has a lower cost to serve. So we manage this company through the EBIT margin. Gregory M. Macosko - Lord, Abbett & Co. LLC: So no real difference on the operating line is kind of what you're saying?

Exactly. Gregory M. Macosko - Lord, Abbett & Co. LLC: Okay, great. And then with regard to Europe. Basically, you're saying that Germany remains strong and it clearly is. And that is, I mean, because of, I guess, 10% organic growth does seem fairly -- sounds very good from a North American standpoint and just looking at the problems over there. So you feel -- you continue to feel that way? Did you feel that way in December as well?

Yes. I mean, we -- again, we have -- again, 6 of our 7 growth opportunities are Kennametal controlled. Gregory M. Macosko - Lord, Abbett & Co. LLC: And finally, the 36% incremental margin. I mean, is that something -- was there anything that affected that more or less in the quarter?

No. It's relatively consistent, Greg. We always said that. When we gave our guidance in July, we said it would be in the low 30s and we're tracking, as anticipated. Now the things that will drive some behavior there is that raw materials are higher, pricing is better. But on average, it's been pretty much in line.

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

Just a couple of real quick ones. Circling back to China, kind of, we've seen some of the emerging markets taking steps towards looser monetary policy to help kick growth, another step back up. Typically, how long do you think it takes from a lag effect standpoint when India or China makes those moves? And what end markets do you think that might manifest in first?

I mean, China is -- typically, it is very quick, 30 days, 60 days. I don't have a good feeling for India. India takes longer, but China is pretty -- they move the economy back and forth pretty quickly. So we expect that the -- to see a bigger positive in the industrial, obviously. We'll probably see a little bit of the opposite, not that our infrastructure will decrease that much, but we will see an acceleration on the industrial as a result of their most recent monetary policy changes.

Right. Well, and since there are more folks planning infrastructure right now, I think you said, is that taking the shape of roads or dams or airports or power plants? Which of those is best for you? What's the right mix to really drive growth for Kennametal on the infrastructure side?

I think repairing overall. I mean, that type of -- the mining is very positive for us. And obviously, all the electric, the power additions, that they're going is very good for us as well.

Yes. And if the rollout could accelerate, I think they're getting their minister under control there. So they may -- we could see some acceleration, and that will benefit on both industrial as well as infrastructure.

Your final question comes from the line of Holden Lewis with BB&T. Holden Lewis - BB&T Capital Markets, Research Division: A couple of things. The first, I believe with WIDIA, how much -- the 25% growth, how much of the mix, what sort of revenue base that you're getting that growth off of? What's the mix of WIDIA business?

I would say there's probably more in the Americas, secondarily probably Asia, and third in Europe. Because WIDIA has been established in Europe. It's a European brand. So I would probably say we're seeing a lot of it with the Americas. And as we continue to work closely with Fastenal, we hope that will continue to accelerate faster in the future. Holden Lewis - BB&T Capital Markets, Research Division: That's always good to happen -- is that 27% that you're seeing kind of broad across the geographies? Or is that -- is Fastenal meaningfully driving that number at this point?

Yes. Fastenal is just starting, so they're not meaningfully driving that but the sequence is, as Frank said, the most growth is coming from the Americas, followed by Asia and lastly by Europe. And the reason for Europe being last is not an economic issue. It's the fact that WIDIA was a European brand and was established in Europe. So the growth potential there is not if I, as in the rest of -- in the Americas and the rest of the world, where WIDIA has absolutely no presence at one time. Holden Lewis - BB&T Capital Markets, Research Division: And then what percentage of revenues is WIDIA?

Less than 10%. Holden Lewis - BB&T Capital Markets, Research Division: Less than 10%. Got it. And then a couple of questions as well on the seasonality. First, it's seasonally unusual for your Q2 revenues to be below your Q1 revenues. But I guess I would assume the fact that, that happened during a period expansion. It would have suggested some slowdown, but you don't it suggests it's happening. Can you give some color as to why you had such a seasonally unusual event in a period where it doesn't usually happen that way?

Well, first, actually, actuals. The first quarter to the second quarter, we average -- just using the euro, euro averaged about $1.44 in the first quarter. The second quarter was $1.37, and you know where is that now. So the euro plays in there. And believe it or not, last year, the work days' decline was only a couple. This year was over -- almost 3.5 reduction in days. We've got a combination of FX and days. And this is relatively consistent with how we built our plant.

Yes. I also want to emphasize that what we're saying is the growth is decelerating. We said that when we gave guidance for 2012, we said that the growth was going to decelerate, which is different than the bottom is falling out. Holden Lewis - BB&T Capital Markets, Research Division: Okay. And then just one other thing, as I see now. Just taking your guidance, it does imply revenue growth in the back half of about 3% to 6%, which we're seeing kind of in line with IP perhaps as opposed to bidding it. And it implies that your earnings should be anywhere from down 1% to up 9% in the second half, which seems reasonably anemic, again in an unreasonable growth environment. Is that just conservatism? Or what's behind that?

It is a forecast. I don't know if you've been listening to this call. Half of the population thinks that the world is falling apart, and the other half of the population you're being part of that, who thinks there's maybe some conservatism in our assumptions. I mean, it's the forecast as we see it. It has puts and takes, and that's the best that we can do at this point. As I told you in last quarter, we're damned if we do, damned if we don’t.

There are no further questions at this time. Are there any closing comments?

No, you can go ahead and announce the replay.

There will be a replay of today's conference available from today at approximately 11:00 a.m. Eastern Standard Time through February 23, 2011, at midnight. The ID number to dial for the replay is (800) 585-8367 or (855) 859-2056. The ID number to access the replay is 34264306. Thank you for participating in today's conference call. You may now disconnect.

This concludes our discussion. Please call me, Quynh McGuire, at (724) 539-6559 for follow-up questions. Thanks for joining us.