Kennametal Inc. (KMT) Q3 2013 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 Third Quarter and Fiscal Year 2013 Earnings Call. [Operator Instructions] Thank you. I would now like to turn the call over to Quynh McGuire, Director of Investor Relations. Please go ahead.

Thank you, Regina. Welcome, everyone. Thank you for joining us today to review Kennametal's third quarter fiscal 2013 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 is also being broadcast live on our website, and a recording will be available on our site for replay through May 24, 2013. 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. Carlos and Frank will provide further explanation on the quarter's financial performance. After the remarks, we'll be happy to answer your questions. At this time, I would like to direct your attention to our forward-looking disclosure statement. The discussion that we'll have today contains comments that may constitute forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve a number of assumptions, risks and uncertainties that could cause the company's actual results, performance or achievements to differ materially from those expressed in or implied by such forward-looking statements. Additional information regarding these risk factors and uncertainties is detailed in Kennametal's filings with the Securities and Exchange Commission. In addition, Kennametal has provided the SEC with a Form 8-K, a copy of which is currently available on our website. This enables us to discuss non-GAAP financial measures during this call in accordance with SEC Regulation G. 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 we are hosting this call from our Kennametal Europe office in Neuhausen, Switzerland. Earlier this week, our Board of Directors and some members of the senior management team were in Milan, Italy, to visit 2 of our manufacturing operations, a facility that produces metal cutting tools and a satellite plant that makes investment casting components. In addition, the team who [indiscernible] Switzerland to see our facility that provides customer solutions and services, primarily for the energy markets. Kennametal has a strong brand recognition in Europe and this region represents a key market for our business. During the March quarter, economic conditions remain challenging globally. As persistent, fiscal concerns and uncertainty affected customer demand for our served end markets. U.S. has slow growth, the eurozone is still contracting somewhat and certain emerging markets underperformed. As a result, global industrial production was negatively impacted as customers delayed spending and held back from inventory restocking. As expected, the decline in customer demand reduced sales year-over-year. However, we realized the sequential increase in revenues with 3.5% sales growth in the March quarter over the December quarter. In addition and very important, our daily order rate reflects sequential growth in each month since December. Overall, we remain positive about Kennametal's long-term growth prospectus given our diverse served end markets. While infrastructure sectors, such as mining and energy, faced near-term challenges. We expect growth construction activity to ramp up with the arrival of warmer weather and continue into the summer and fall. Regarding commercial markets, the transportation sector is beginning to see some improvements and commercial aerospace continues to show strength. In addition, we expect that our general engineering business will experience a ripple-effect benefit when demand returns. Last week, Kennametal participated in bauma 2013 in Munich, Germany, which is a machinery and equipment trade show related to industries such as construction, mining, energy and building materials. The event had a record-breaking number of exhibitors as well as attendees. There were approximately 530,000 attendees from more than 200 countries and more than 200,000 of those were from outside Germany. This is the largest international representation in this event's history. We believe the high-order activity reported by bauma 2013 is an encouraged indicator of longer-term sentiment for the industry. In the meantime, we continue to increase our addressable market through implementing our WIDIA brand channel strategy, as well as integrating our Stellite acquisition to realize sales synergies long-term. We will continue to invest in innovative technologies to depreciate Kennametal products in the marketplace and improve productivity for our customers. And now I would like to provide an overview of trends that we see -- we are seeing in the served end markets. In aerospace, production is going strong and many programs are increasing production rates with potentially more to come. According to IHS Global Insight, the worldwide commercial production is expected to grow approximately 14% in calendar year 2013. In addition, Boeing recently announced that it has completed testing in the battery used in its 787 Dreamliner planes and is waiting FAA approval. Although this testing affected plane deliveries, the manufacturing activities are still maintained at a high level. In general engineering, distributors continue to be cautious and are keeping inventory levels low. Looking forward, business sentiment indicators are trending more favorably in the U.S. The eurozone is still weak. In emerging markets, such as China, India and Brazil, customer demand trends have moved up and down but remain positive. In transportation, auto production was lower in most geographic regions with a year-over-year decline of 8.5% globally. However, overall production levels for calendar year 2013 are forecasted to grow approximately 3%. Currently, the average age of light vehicle fleet in the U.S. has increased to a record 11 years. This is proof of pent-up demands. And eventually, aging vehicles need to be replaced. Low interest rates and an improving housing market may influence some customers to borrow for big-ticket purchases again. For Western Europe, the outlook for 2013 will be challenging for manufacturers who are closely tied to eurozone domestic markets. Automakers with broad geographic diversity and exposure to premiere export markets will perform better. In China, a more favorable economic environment is expected as it is forecast to increase 10% year-over-year, reaching 20 million units in calendar year 2013 and suppressing Europe to become the leading manufacturer of light vehicles. Moving to the energy market. The world rig count decreased by 5% year-over-year. At the end of March, natural gas prices in the U.S. steadily increased to around $4 per MBtu, which is the first time at this level since September 2011. Another favorable indicator is that the storage level of natural gas decreased 2% below the 5-year average, which is a significant depletion from the prior month's storage of 16% above the 5-year average. Natural gas from existing wells that have been capped will add to supply levels first and then drilling activity will ultimately increase. Longer term, pipeline construction remains robust as producers are expected to add 30 billion cubic feet per day of capacity by 2016. Since 2012, more than half of this build has taken place in the Northeast region of the U.S., representing approximately $2 billion in capital investment. Regarding the mining industry, coal production reflects further slowing worldwide. U.S. production is projected to contract approximately 2% for calendar year 2013. It has been a challenging market with 87 mine closures over the past 12 months and additional closures are anticipated to the remainder of calendar year 2013. However, demand is expected to stabilize and modest growth of approximately 3% is forecast for calendar year 2014. In the near term, the downturn in domestic production can be partially offset by overseas exports to China or increased production in countries such as Australia and South Africa. Going forward, coal continues to be an important market for Kennametal as it is a significant part of electricity generation, steel production and other manufacturing processes globally. In the road construction and rehabilitation sectors, state governors -- governments in the U.S. are focused on spending for maintenance work rather than new projects. With funding available from federal highway bill, hoarding activity continues to build. However, the construction season was delayed due to cold weather and winter storms extending into the end of March and through part of April. In Europe, highway rehabilitation markets are expected to remain relatively challenging due to fiscal issues. From a geographic perspective, the recent news on the U.S. economy has been more positive and the fiscal threat of reaching a federal debt ceiling has been . However, the impact of spending sequesters remains and IHS Global Insight has estimated that a full sequester would cut half a percentage point from real GDP growth in calendar year 2013. In the eurozone, recessionary forces are diminishing, but significant growth is not yet in sight. After contraction in the December 2012 quarter, the eurozone economy expected to see flat activity through calendar year 2013 and will likely begin a slow recovery in 2014. Fiscal austerity, high consumer debt levels, rising unemployment and political uncertainty are all contributing to subdued economic outlook. In China, real GDP growth strengthened to 7.9% year-over-year in December 2012 quarter, reflecting an increase from 7.4% in the September 2012 quarter. This modest acceleration, the first in 7 quarters, was led by consumer spending and exports. In the March 2013 quarter, however, China's economy grew 7.7%. So there is a continued caution due to the fragile nature of recovery. Kennametal has successfully managed through stronger headwinds in the past. As always, our global team made business adjustments as needed, continued to execute our company-specific strategies to further strengthen our enterprise and deliver double-digit operating margin even in a challenging macro environment. We further streamlined our business by employing lean initiatives, identifying outsourcing opportunities and implementing cost-containment measures for both manufacturing and operating expenses. Those initiatives are aligned with our corporate culture and will continue to position Kennametal for future growth. We remain focused on balancing our global presence to generate revenues equally from North America, Western Europe and rest of the world markets. We continue to diversify our mix of served end markets to generate growth opportunities, lower volatility and migrate risk to downside exposure in cyclical industries. In addition, I'd like to mention that we celebrated 2 major milestones during the March quarter. One is that we celebrated our 75th anniversary as an industrial technology leader with a record of delivering productivity and innovation worldwide. The second milestone is that Ethisphere Institute named Kennametal for the second consecutive year as one of the world's most ethical companies. This is a strong testament to our commitment to our code of ethics, investment in innovation and sustainable business practices, as well as activities designed to improve corporate citizenship. Most importantly, it is a great honor and tribute to the Kennametal's employees worldwide. I'll 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 start with a summary of the March quarter, followed by a review of the quarter details and I'll close with the current view on our outlook for the remainder of fiscal 2013. As Carlos said on balance, we delivered solid results with improved profitability from the December quarter despite a mixed macro environment for our served end markets. Looking at our market analysis for sales by region, we experienced the most negative impact in North America. This was mostly driven by infrastructure end markets, where there were softness in North America underground coal mining including additional mine closures, coupled with project delays in our energy business. General engineering is also down in North America as customers continue to operate at low inventory levels. However, it's important to note that throughout the March quarter, both our Industrial and Infrastructure segments saw sequential growth in each month since December. Also, a few other items to highlight as we again delivered double-digit EBIT margin of 11.2% and excluding the Stellite acquisition, our EBIT margin was 11.8%. We have strong free operating cash flow in the March quarter led by our inventory reduction initiative in which we reduced finished goods inventories by approximately $30 million. Although this initiative lowered our EBIT margin by 110 basis points, it was consistent with our long-term strategy to maximize cash flow. We further enhanced our liquidity and debt maturity profile by amending and extending our revolving credit facility at favorable pricing. We completed the sale of 13% of shares in our India subsidiary, resulting in net proceeds of approximately $27 million and I'll touch on this in a bit more detail later. And lastly, Stellite's acquisition was accretive to our results by $0.02 per share despite the headwinds in its served markets. Note that our proactive cost-reduction measures as well as our more efficient organization structure helped us deliver double-digit adjusted operating margin of 12.1%, despite the continued market challenges in our company's inventory reduction efforts. We continue to have cost-containment actions in place and are managing our business to market conditions while staying focused on near-term cash flow objectives as well as the long-term growth strategies. Now I'll walk through the key items in the income statement. Sales for the quarter were $655 million and this compares to $696 million in the same quarter last year. Sales decreased by 6%, reflecting a 6% organic decline, a 5% decline from fewer business days and 1% unfavorable effect from currency exchange, partly offset by a 6% increase from Stellite. And that's 2 additional months in the quarter compared to last year since we acquired Stellite on March 1 in the prior year. Turning to the segments' business review. Our Industrial segment sales of $374 million declined 11% from the prior year quarter. This was due to 5% organic decline, a 5% decline from fewer business days and a 1% unfavorable effect from currency. On an organic basis, sales declined 12% in general engineering, 2% in transportation and this was partly offset by sales growth of 14% in aerospace and defense. General engineering was unfavorably impacted by lower demand levels as both direct and indirect customers continue to operate cautiously, maintaining lower-than-normal inventory levels. Transportation experienced lower vehicle production rates in most geographic regions, and aerospace and defense sales continue to benefit from the increase in commercial aircraft production. Regionally, sales in the Industrial segment decreased by approximately 12% in the America's, 10% in Asia and 9% in Europe. Our Infrastructure segment sales of $282 million increased 1% from the prior year quarter, driven by Stellite contributing 15% growth, partly offset by an 8% organic sales decline and a 6% decline from fewer business days. On an organic basis, sales declined 15% in energy and 6% in the Earthworks markets. Energy customers continue to delay orders due to ongoing decline in the oil and gas rig counts primarily in North America and weaker underground coal demand in North America, as well as 3 additional mine closures during the quarter and a delay in the start of road construction season due to inclement weather in March affected our Earthworks business. Regionally, including the 1 month of Stellite organic growth, sales increased by approximately 18% in the Americas, 6% in Europe and remained relatively flat in Asia. Now a recap on our operating performance. Our gross profit margin was 31.8% compared to 35.4% last year. The decline was due to decreased volumes and less absorption of manufacturing costs, resulting from both the lower sales as well as our inventory reduction efforts. The inventory reduction had an unfavorable impact of approximately $6 million or 110 basis points on a gross margin for the base business. This quarter's results also includes the effect of Stellite, which is as I've said in the past, is a lower-gross-margin business versus the Kennametal base business. The current year gross margin benefited from -- the prior year gross margin benefited from strong organic growth of 8% in the prior year. Our operating expense declined $11 million year-over-year due to the containment of discretionary spending, lower employment and related compensation costs and favorable foreign exchange. Operating expense as a percent of sales was 19.6% for the quarter, down 30 basis points from the prior year of 19.9%. This represents ongoing cost discipline from our global team, coupled with the effect of Stellite, which has a lower SG&A percentage versus the Kennametal base business. Our operating income was $75 million compared to $103 million in the same quarter last year. Our operating income included $2.9 million of Stellite operating income contribution for the quarter, and Stellite net operating loss, which included acquisition-related costs, totaled $4.6 million in the prior year. Operating income declined due to lower absorption of manufacturing costs related to the sales volume and our ongoing inventory reduction initiative, partly offset by lower operating expenses. And as I said earlier, our operating margin for the March quarter, excluding the acquisition of Stellite, was 12.1%. Looking at the business performance by segments. The Industrial segment's operating income was $45 million compared to $71 million in the same quarter of the prior year. Industrial's operating income decreased due to the lower absorption of manufacturing costs related to the sales volume and the ongoing inventory initiative to reduce inventory. Industrial operating margin was 12% compared with 17% in the prior year. The Infrastructure segment operating income was $32 million compared with $34 million in the same quarter last year. Infrastructure's operating income benefited from the Stellite operating income of $2.9 million and Stellite's net operating loss, as I said prior, totaled $4.6 million loss in the prior year period. Operating income decreased due to the effects of the organic sales decline and the lower absorption of the manufacturing costs. And Infrastructure's adjusted operating margin was 13.4% for the March quarter compared with 15.1% in the prior year. Now I'll walk through the rest of the income statements. Despite higher average debt levels attributable to the Stellite acquisition, our interest expense decreased by $500,000 year-over-year in the March quarter to $7.5 million. This decrease was due to favorable effects from the refinancing of our 7.2% notes that matured last June, which will replace lower interest of 3.875% 10-year notes maturing in 2022. Our effective tax rate was 18.5% for the quarter compared to 20.4% in the prior year. The decrease was primarily driven by the extension of the credit for increase in research activities contained in the American Taxpayer Relief Act of 2012 that was enacted during the current quarter, partly offset by higher relative U.S. earnings in the current year relative to the rest of the world. Regarding the bottom line performance. We reported the March quarter diluted earnings per share of $0.67 compared with $0.93 in the prior year quarter. And as I said earlier, the current year earnings per share includes $0.02 per share accretion from Stellite, while the prior year earnings per share included $0.05 per share of acquisition-related costs. Turning to cash flow. Our year-to-date cash flow from operating activities was $150 million and this compares with $164 million in the prior year. Cash flow benefited from our ongoing inventory reduction initiative, which reduced finished goods and WIP by approximately $40 million on a year-to-date basis. Our net capital expenditures were $52 million compared to $56 million in the prior year and our free operating cash flow year-to-date was $98 million compared with $108 million in the prior year. We continue to focus on further improving our cash flow metrics and are making significant progress towards achieving our goal of 100% conversion of net income to free operating cash flow. In fact, on discrete basis, our March quarter free operating cash flow was 144% of net income. We remain committed to balancing our priority uses of cash. During the March quarter, we purchased 786,000 shares of our stock, totaling 2.1 million shares on a year-to-date basis. And we have approximately 6.5 million shares remaining available under the current stock buyback program. Also during the March quarter, we sold shares in our subsidiary in India in order to comply with the Securities and Exchange Board of India stock exchange rules, which require a minimum of 25% public float. Prior to the sell-down, we owned 88% of our India subsidiary. In accordance with the rules, we sold 13% of our shares and received approximately $27 million as a result. We now own 75% of the Indian subsidiary and there was no P&L impact on the transaction except for the noncontrolling interest going forward. We continue to be confident in our strong cash flow generation and we'll stay consistent to our capital structure principles. We have investment-grade ratings and stable outlooks from all 3 rating agencies and remain committed to maintaining them. We continually strive to balance key priorities by prudently deploying cash in strategic growth investments and acquisition opportunities, returning excess cash to shareholders and reducing debt. For the year-to-date period, we returned 81% of our net earnings to share owners. The combined payout ratio reflects $78.5 million in share repurchases and $38.4 million in dividends. Our net income before noncontrolling interest was $144.7 million and combined share repurchases and dividends represent 119% of our year-to-date free operating cash flow of $98 million. As always, we remain active on the acquisition front to identify and develop potential candidates. We continue to be highly disciplined in our capital allocation process to ensure that we invest in initiatives with the highest share owner returns. Turning to the balance sheet. Our balance sheet remains strong. As we've previously stated, we remain committed to reduce an approximately $60 million of inventory in fiscal 2013, primarily from finished goods and work in process inventory. During the quarter, we reduced finished goods inventory including WIP by approximately $30 million and this is in addition to the $17 million that we reduced in the December quarter. At March 31, 2013, we had just $47 million in short-term debt leaving availability of liquidity of more than $0.5 billion on our revolver. Total debt was $751 million and Kennametal had total cash of $322 million with the majority of this cash residing presently overseas. Our net debt was $429 million at quarter end, a decrease of $61 million versus the December quarter due to strong free operating cash flow and approximately $27 million from the Kennametal India share sale proceeds partly offset by share repurchases and our March quarter dividend. Our debt-to-cap ratio at March 31 was 30% compared to 25.3% at June 30, and our adjusted return on invested capital was 10.8%. We continue to actively manage our pension plans and enjoy the benefits of our adoption of a liability-driven investment strategy over 6 years ago and as a result, our U.S.-defined benefit plans remain 100% funded. In April, we took additional steps to further enhance our liquidity and capitalize upon current market conditions to extend our debt maturity profile. We amended our existing $600 million syndicated revolving credit facility to extend the maturity at April 2018. We felt it prudent to move forward at this time to lock in current favorable pricing and reduce exposure to future market uncertainty. This transaction closed on April 5 and represents a third event over period of approximately 2 years and a series of key strategic financing initiatives, which began with the refinancing of our $300 million 10-year notes that matured last June. We went to the bond market twice in the last 14 months and took advantage of the current low-interest rate environment to place attractive fixed-rate debt issuances for Kennametal. Our November, 400 million, 7-year, 2.65% public note issuance significantly increased our liquidity and generates an attractive weighted average overall interest rate of 3%. Kennametal's debt maturity profile has been effectively diversified and extended. Our nearest debt maturity is now 2018. Quick update on the acquisition of Stellite for you. The integration of Kennametal Stellite continues to be on track. The June quarter is an important period for the integration, as we cut over 4 of the principal operating locations onto SAP. The SAP implementation will accelerate future synergy opportunities, both costs and revenues. During the June quarter or during the third quarter, Kennametal Stellite also experienced weakness in its core end markets, particularly its energy and end markets in North America, the construction market in Asia and continued softness in the automotive in Europe. We continue to manage operating and integration costs to partly mitigate the adverse effects on our operating results. The delayed recovering served end markets for Kennametal Stellite is impacting its contribution in fiscal 2013, and in the fiscal third quarter, Kennametal sales were $61 million, and Stellite contributed $0.02 per share. Now let me turn to our outlook for the remainder of the fiscal year. We have revised our forecast in consideration of the global economic conditions and customer demand patterns that Carlos touched on. So the assumptions that are included in our guidance include a benefit from 2 additional work days in the June quarter compared to March in the prior year quarter. Weak conditions will likely persist in North America underground coal mining. However, we expect increased activity in highway road construction, slightly improving energy activity with drilling activity expected to remain flat in the June quarter. Longer-term, the industry is preparing for growth as natural gas prices rise and storage levels continue to be depleted. Improving sales for transportation and general engineering with limited effects from destocking now that customers have lower inventory levels. We believe destocking has slowed in the Americas, and Asia is beginning to show positive signs. Our noncontrolling interest expense will increase due to Kennametal's India stock sale. We now own 75% of our subsidiary compared to 88% previously. And the effective tax rate for the full year is now expected to be approximately 23%. We're on track to reduce our finished goods inventory and WIP by approximately $60 million for the fiscal year, and we again expect to deliver strong free operating cash flow in the fourth quarter in excess of net income. Positive note is that our monthly order rates reflect a sequential increase over prior quarter, and we expect continued modest improvements, particularly in our industrial end markets. As a result of these factors, we now expect our fiscal '13 sales to decline in the range of 5% to 6% with organic sales decline ranging from 8% to 9%. We are reducing our earnings per share guidance for fiscal '13 to the range of $2.45 to $2.55 per share, and included in this outlook is the accretive contribution of the Stellite acquisition net of integration costs, which is now expected to be a range of $0.05 per share to $0.10 per share. We expect to generate cash flow from operations between $260 million and $280 million for the remainder of the fiscal year, and based on anticipated capital expenditures of $90 million to $100 million, we expect to generate between $170 million and $180 million of free operating cash flow for the full fiscal year. Overall, we're managing the business very well for the factors we can't control or deal with and the near headwinds as needed, and we continue to focus on our many growth opportunities and the consistent execution of our strategies. Now I'll turn it back to Carlos for some closing comments.

Thank you, Frank. As we move forward, we'll continue to execute the same strategies that have transformed Kennametal into a company that can deliver profitable growth throughout the economic cycle. During this fiscal year, we have consistently delivered double-digit operating margin performance despite the challenging market conditions that impact sales growth and lower cost absorption due to our inventory reduction efforts. The results validate our company-specific initiatives to grow sales, invest in operational efficiencies and maximize profitability. In addition, we'll continue to capitalize on our strong balance sheet to increase shareholder value. Kennametal has a track record of generating strong cash flows, we'll remain disciplined in our capital allocation process to include stock buyback, acquisitions, capital expenditures and dividends. In summary, we'll continue to serve customer demand by further balancing our served end markets, business mix and geographic presence. We'll remain focused on maintaining operational excellence throughout our company. Our goal is to drive profitability and returns while doubling revenues in 5 years and maximizing cash flows. Thank you for your interest in Kennametal, and we'll now take questions from you.

[Operator Instructions] Your first question comes from the line of Julian Mitchell with Credit Suisse. Julian Mitchell - Crédit Suisse AG, Research Division: I just wondered on the issue of production versus sell-through. The gross margin went up, I guess, 30 bps sequentially in Q3. Assuming it's sort of a flattish SG&A-to-sales ratio in Q4 sequentially, suggests your guidance maybe has it up about 100 bps or so in Q4. Is that roughly correct? And if you could just give a broader update on production versus sell-through and at what point do you think we should see the 2 match up again?

Yes, Julian. This is Frank. I think you're right, sequentially Q2 to Q3. We had originally anticipated taking out the remaining inventory reduction of about $47 million. So we did a little bit more in the March quarter, the $30 million, not that it was going to be equal last quarter of $20 million and $20 million give or take. But I think the fourth quarter gross margin will be a little bit better. We will have some additional benefits from the line [ph] from the additional work days, so less of a drag on the capacity utilization. We're also experiencing slightly lower raw material costs now that we flushed through some of the higher cost in the fourth quarter, and there'll be a slight bump-up as well, in my opinion, on the Stellite acquisition from some of the sales synergies and some of the integration activities that we started on previously. So I expect it to be up a little bit higher than what you anticipated in the fourth quarter. Julian Mitchell - Crédit Suisse AG, Research Division: And then just on a -- within the industrial business, the Americas seems to see a sort of an accelerated decline in Q3. I think they were down 12% organically year-on-year versus down 8% year-on-year in the December quarter. And yet, if you look sort of globally and so on the PMI, just slightly better in the Americas versus other regions. So maybe just give an update on industrial Americas. And do you think that we should see that minus 12% improve much in the June quarter?

Yes, I think we will see it. I think it's -- it was a little bit more pervasive with the destocking. I think that has somewhat subsided. And then even though it's in the industrial, the slowness in the energy also has a ripple effect on the general engineering side, and I think just some of the fiscal concerns and some of the cautious in the third quarter as people get a little bit more comfortable with the payroll cut and the debt sequester. I think we'll see a little bit more activity going forward. And it was basically the same between our direct and indirect, but we continue to see the daily rate in the industrial business gain a little bit of a steam, and we see a strong correlation as well as transportation starts to pick up a little bit. The general engineering portion of our business tends to lag a couple of quarters, so we're starting to see a little bit more activity start to come through on that side as well. So I expect it to be a little bit better in the fourth quarter, all being we do have a little bit easier comp in Q4. Julian Mitchell - Crédit Suisse AG, Research Division: And then just lastly, the cash balance, I mean, your cash balance has tripled in 6 months, just the gross cash. What -- I mean, are you anticipating a sort of accelerated buyback run rate from here. I guess, year to date, you've been running at about 700,000 shares per quarter on average year to date. Are you anticipating an acceleration in that run rate?

I'll answer it this way for you. We committed to the beginning of the fiscal year to repurchase 2.5 million shares back. We will do at minimum that amount.

And I'll remind everyone that we still have a 6.5 million authorization left, so we have flexibility.

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

Can you give us some idea of what's going on and versus end markets? One clarification, we have, what, $13 million more of inventory to take out in the fourth quarter if you're going to get to $60 million. You're at $47 million. I know I should [ph] but can you...

Yes, I'll start on the inventory question. So Eli, let me give you the numbers. Like we said last quarter, we would take out $60 million of which, we did $17 million in the quarter, and we did another $30 million. So the last 2 quarters, we did $47 million, but in the first quarter, inventory in those categories was up $7 million, so I -- in the script, I said year-to-date we're at $40 million, so this would imply $20-ish million in the fourth quarter. Now the caveats there is as we continue to see some of the faster moving items, particularly in the industrial side, the A items turn [ph], we'll monitor our fill rates. And if we think we need to increase for the second half any of the fast-moving items, we may not hit that, but the goal still remains to do the $60 million. Of which, $20 million will occur in Q4.

And Eli, what was your question relative to the markets?

Yes, I was just trying to get some characters, some color on what's going on in the underlying markets. I mean industrial markets are sort of in a status quo, but the inventory seemed relatively low at this point. So you're just prodding along with current activity. And that's what you'd expect to happen until the market change. I guess my concern is the infrastructure where energy remains quite weak or so and we have more inventory liquidation to be taken out in the end markets and that part of the business. And is that year-over-year comparison improvement delayed till sometime in the middle of fiscal '14?

Well, I mean, I think that we have seen sort of the destocking, and really this month, this past month, we've seen that activity sort of end as far as we can tell at this point. And one of the proofs is that we've seen sequential, in the daily rate, sequential growth. We, at this point, anticipate that the industrial will come back faster but maybe by a quarter or so and the infrastructure to follow that. And what's driving the infrastructure is going to be around the construction. So the construction was expected the activity to start really this quarter, but because of the harsh winter, the weather, again, we have the quotes. I think the municipalities are ready go. I think we'll see that activity right now in the next few weeks.

I mean I...

[indiscernible] yes, the one thing I would add on the energy side, I don't think there's a lot of inventory in the energy pipeline of any magnitude. And it's just very -- some are quick [ph] we see the -- with the gas prices, where they're at. we know storage levels are down. And what could really be an inflection point if we have a hot summer because we have a normal winter and if you get a normal summer, this thing can snap back a lot quicker as you know.

Okay. And can we just have some commentary what's going on in pricing in the industry? Of course, is there any material change in pricing, whatsoever, given the weakened industry conditions? And maybe an update on what's going on with Fastenal and the video line and versus seeing some inroad from Amazon in the marketplaces?

Yes, I mean, I would say there has been no change in the pricing, so we'll continue to get -- obviously, we have -- the pricing that we are getting is the tail end of the pricing that we had in place last year. So there was -- we have not given price in any areas. And I think our Fastenal business continues to grow at a significant pace. The base is small, and we are, both myself and Will, are very excited about the potential of this brand. And the Amazon is not really going to affect this brand because people need to help, need help in utilizing, applying sort of the principles of this brand. I mean, you're going to see Amazon more in the high-speed steel and some of the more standard type of products.

Your next question will come from the line of Ann Duignan with JPMorgan. Damien Fortune - JP Morgan Chase & Co, Research Division: This is Damien Fortune on for Ann. Could you guys expand on the sequential improvement in orders? Was most of it being driven by improvement from the OEMs? Or is it more distribution?

It's really both. I mean, we're seeing improvement all around in the daily orders sequentially. And at the last call, we said that we believe that the bottom had been in November, December time frame. We now have a basically 3 months to validate that, and I can tell you right now that the current month seems to be in the same -- going the same path. Damien Fortune - JP Morgan Chase & Co, Research Division: Okay. Great. And could you guys give us just a sense of what you're thinking over the cadence of orders over the next, call it, 6 months or so?

We're not going to get into fiscal '14 because we're going to be wrapping up our year. I think you guys can look at the normal seasonal patterns. But as we go forward, as you know, the sales comps as we get into fiscal '14 will be relatively easy to compare to. And some other items that we're contemplating going forward is we shouldn't have the inventory reduction issue next year. We should continue to have a tailwind from some raw materials. Stellite should pick up compared to this year from an integration contribution, and we expect to have a better mix as we get into the next fiscal year, as we continue to be challenged this year with the destocking and the inventory burn. All those items should not necessarily recur in fiscal '14, but as far as the outline, I think, you guys can look at all the global GDP and the industrial production numbers. It's, in theory, setting up for a decent year, but we'll be a little bit cautious and be able to update you when we get to the July call.

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

I'm wondering, as you've done a good job pulling back your SG&A expenses because demand's been pretty weak, I'm just wondering as we start to see some of the volumes recovering next year, what your confidence level of holding that expense growth down as volumes improve.

Well, I mean, I think traditionally, we have been able to do that. I mean, we have demonstrated that we did that in the last -- coming out of the last recession. So there was nothing that really would be abnormal and unusual. And by the way, in the last recovery, the recovery was higher and faster than I think it's going to be going forward. So I think we have a better chance to do it. It was more difficult to do it last time than it is going to be now.

Yes, Adam, the one thing that I'll add, as we continue to start going for, you probably will start seeing additions to the sales force. So we're willing to -- we're going to make some investments, particularly in Americas to help us take some additional share as we get into fiscal '14. And as we stated what our top line to grow faster, we're going to start making some investments to help accelerate the top line growth, particularly around the direct field sales organization and adding select distribution.

Okay. Got it. Actually, could you expand on that comment a little bit more, Frank? The strategy in the last couple of years has been to expand the presence and distribution. And I guess, that seems to be kind of a big change of what we had been thinking [ph] .

No, I think...

No, no, it's not a big change. I mean, I think that our distribution is growing at a much faster pace than our direct sales. It's going to continue to be that way, still our strategy. We didn't change anything. But sooner or later, as we get bigger and bigger, we got to add to the sales -- direct sales force, even though we're going to continue to grow indirect at a higher pace. Nothing's changed. It's just...

Okay. Got it. And then just quickly I think I heard $6 million gross margin from the inventory reduction. Could you clarify that. Is that -- that was just in the quarter? Is that year to date? And then, Frank, could you give us the impact of the inventory reduction by business perhaps?

Yes. The $6 million was basically the March quarter alone. That's in addition to the $5 million that I called out last quarter. I'm not going to break it down overall by business, but there's probably a little bit more inventory reduction on the industrial side than there was on the infrastructure because infrastructure has a little bit more raw material content products in there, and the focus was really more on the industrial side. So the $6 million is in addition to the $5 million. The first quarter, we had a benefit of about $1 million and change, so that would put us basically at about $11 million year-to-date impact on the gross margin with the bigger hits being in the December and March quarter.

Your next question will come from the line of Ross Gilardi with Bank of America.

Could you talk just a little bit about when you look at your different end markets and the weakness in coal, I think, is well understood. But if you think about sort of the year-to-date declines you've seen in demand, how much of that would you characterize as just cyclical versus structural? And then I guess when we think about you getting back to a 15% margin at some point in the next couple of years hopefully, is there a detrimental impact on mix from some of these changes in the demand patterns that might inhibit you from getting back to that level of margin?

No, I would say that the decline is due to the cyclicality of the business. I mean, I think that as the supply chain is a lot tighter now, so I think it is going to take -- as we see the IPI and we see the PMI getting better, then as the serious put [ph] inventory in their stock and so forth, we'll see that coming back. And I would say that even with the inventory reduction in place, we are harboring around 12%. So we have a lot of capacity. So as this thing comes back, we're going to experience a substantial incremental margin improvement. So we are -- we feel that we are very well positioned for the growth.

But what do you think is the risk though that some of the energy markets, some of the markets you're talking about in Europe in the transportation sector, what you're referring to a lot of destocking and restocking type dynamics, but what's the risk that these markets are just kind of dead for a while from here?

Well, I mean, I think that if you look at -- we're not anticipating that coal is going to come back soon. I mean -- and I think that, as we said, for example, the automotive in the U.S. on average, 11 years is the life of a car. I mean, sort of there's a lot of pent-up demand that is going to come back. And so I think the only risk that we have that we can see of taking a while to recover is in the coal. And the coal -- and is probably primarily in U.S., and I think that's a smaller percentage of our total sales. So I think we can experience good growth starting this quarter or next quarter I mean.

Yes. The general engineering should get better as Fastenal gets a little bit more engrained. Particularly in North America, we expand that. That's in the sweet spot with a good margin business. Aerospace continues to have a long cycle as you know. That's going to grow. If it was a little bit bigger, we continue to focus products in that area. And at your point, energy is a good market, and I think with our focus strategy, just not the focus on the drilling, and taken all related aspects, there's a much bigger sandbox that we can drive a lot more value to our customers with our full product portfolio, not just our industrial side. So I think the risks are somewhat limited there, but I think the industrial continue to go stronger. And as Carlo said, mining's going to be what it's going to be, but it's still a good market longer term.

Okay. And then on Stellite, you gave some detail there, some of the dynamics with sales and profits. But are the challenges that you've had with Stellite, would you say are they just purely demand and end market related? Is there anything going on operationally with the business or distribution of other products?

It's a 100% market driven. As a matter of fact, in the cost side of the integration, we are actually ahead of plan, and we're really a year into this integration. And as I said, the board visited one of their largest sites. And we are extremely excited about having Stellite as part of our family. We could use a couple more.

And then just lastly, your Infrastructure segment, your profits at least on a year-on-year basis were fairly stable, almost flat despite the decline in sales. I know some of that was related to Stellite, but do you think you can actually turn positive in the Infrastructure segment this quarter on a year-on-year basis from a profitability standpoint?

Yes. That's a good question. It's going to be close. It'll depend on how construction kicks in here sequentially and if we don't get -- every time, we say we think minings somewhat bottom, we see some additional mine closures. So it'll really depend if we have less closures or no additional closures going forward. Construction kicks in a little bit here. Depending what happens with the energy side, we could potentially, in a best case, yes, definitely get there.

Your next question will come from the line of Joel Tiss with Bank of Montréal.

It seems like a lot of people are dancing around this question. How big is mining? Can you give us a sense in terms of revenues or operating profits?

5% to 6%.

Of revenues, right?

Yes. That's the U.S.

Okay. And it's fair still to assume that, that's more profitable than the overall company, right?

No.

No, not at all. No.

Oh, okay. Well, good. And then can you -- just 2 like bigger picture things. Are you seeing anything changing on the competitive landscape front? And also, can you give us your sort of -- Frank gave us a little hint of capital allocation or reallocation. Can you give us more of a sense, do you think in the next 12 months we're more likely to see acquisitions or share repurchase and/or combination?

You make a good prosecutor, Joel. I think, I mean, the answer depends obviously. We can't forecast the acquisitions. I mean, we are constantly talking to people, and as I mentioned before, it -- we negotiated for Stellite for over a year, and we thought there we're going to be closer. And every time we were close enough, something happened because we are very disciplined about our acquisitions. And the other question was relative to the market?

Yes, yes, about the competitive landscape. Is it -- is anything changing there?

Nothing really changed. I mean, we really don't see, I mean, don't see anything that really is worthwhile noting to be honest with you. I mean, I think we continue to make inroads into the distribution and the indirect channel. We're happy with that, and our partners are happy with that. So I think that as the market comes, I think we can accelerate the indirect sales more so than we did before because we're better positioned with the -- in directional than we ever been before.

Next question will come from the line of Steven Fisher with UBS.

Now that you're starting to see some of these sequential increases in orders, just wondering how you're thinking about cost-reduction activities. And it sounded like your answer to Adam's question earlier was that you've now shifted to investment mode rather than cost-reduction mode. Is that the right way to think about it?

Yes.

Yes, and we're going to stay disciplined, obviously, until we see a better -- I mean, the incrementals are not exciting enough at this point for us to make some measured shifts. But in reality is that we're going to continue to exercise the discipline that we've had, and we are going to start to make investments in the marketplace.

Yes, and Steve, when we look at -- we're definitely going to make the investments where we need it to be in the sales force-related area. But as we've been saying along, the first thing we have to do internally is we talk about trying to fund this S in the SG&A with the G&A reduction. So we continue to maintain that discipline as your underlying theme where we're trying to trade off dollar for dollar. And we if feel that we have opportunities to launch some additional initiatives to drive the top line, we're going to make some of those investments.

Okay. And then it sounds like the U.S. highway constructions off to a slow start, even through early April. How long do think it's going to take to really pick up to the full seasonal run rate? And then what have you assumed for that for the June quarter?

Yes. We think it'll maybe kick in, in late May, June-ish, in the time frame there. And you got to remember too -- there's another factor there. The longer they delay to repair the roads and the tougher the winter is, the more repairs they're going to need to make. So we're going to continue to monitor this one. I think we've got through most of the snow for -- with the exceptions of like in Minnesota and a couple of those other areas, but we think it should start to pick up here in May.

This will conclude today's question-and-answer session.

Thank you. This concludes today's earnings call. Please contact me, Quynh McGuire, at (724) 539-6559 for any follow-up questions, and thank you for joining us.

Today's call will be available for replay beginning at 12:00 p.m. Eastern Time today and lasting through midnight Eastern Time on May 25, 2013. The conference ID number for the replay is 28030042. The number to dial for the replay is (855) 859-2056 or (404) 537-3406. This concludes today's discussion. Thank you for your participation. You may now disconnect.