Kennametal Inc. F4Q10 (Qtr End 06/30/10) Earnings Call Transcript

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 |  About: Kennametal Inc. (KMT)
by: SA Transcripts

Kennametal Inc. (NYSE:KMT)

F4Q10 (Qtr End 06/30/10) Earnings Call

July 29, 2010 10:00 am ET

Executives

Quynh McGuire, Director of IR

Carlos Cardoso - Chairman, President and Chief Executive Officer,

Frank Simpkins - Vice President and Chief Financial Officer

Marty Bailey - Vice President, Finance and Corporate Controller,

Analyst

Ann Duignan - JPMorgan

Eli Lustgarten - Longbow Securities

Andy Casey - Wells Fargo Securities

Henry Kirn - UBS

Adam Uhlman - Cleveland Research

Chuck Murphy - Sidoti & Company

Holden Lewis - BB&T Capital Markets

Steve Barger - KeyBanc Capital Markets

Joel Tiss of Buckingham Research Group

Operator

Good morning. My name is Regina and I will be your conference Operator today. At this time I would like to welcome everyone to Kennametal’s Fourth Quarter and Fiscal Year 2010 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)

At this time I would like to turn the call over to Quynh McGuire, Director of Investor Relations. Ms. McGuire, you may begin.

Quynh McGuire

Thank you, Regina. Welcome everyone. Thank you for joining us to review Kennametal’s fourth quarter fiscal 2010 results. We issued our quarterly earnings press release earlier today. You may access this announcement via our website at www.kennametal.com. Consistent with our practice in prior quarterly conference calls, we’ve invited various members of the media to listen to this call. It’s also being broadcast live on our website, and a recording of this call will be available on our site for replay through August 29, 2010.

I’m Quynh McGuire, Director of Investor Relations for Kennametal. Joining me for our call today are Chairman, President, and Chief Executive Officer, Carlos Cardoso; Vice President and Chief Financial Officer, Frank Simpkins; and Vice President, Finance and Corporate Controller, Marty Bailey. Carlos and Frank will provide further explanation on the quarter’s financial performance. After their remarks, we’ll be happy to answer your questions.

At this time, I’d like to direct your attention to our forward-looking disclosure statement. The discussion we’ll have today contains comments that may constitute forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve a number of assumptions, risks, and uncertainties that could cause the company’s actual results, performance, or achievements to differ materially from those expressed in or implied by such forward-looking statements. Additional information regarding these risk factors and uncertainties is detailed in Kennametal’s filings with the Securities and Exchange Commission. In addition, Kennametal has provided the SEC with a Form 8-K, a copy of which is currently available on our website. This enables us to discuss non-GAAP financial measures during this call in accordance with SEC Regulation G. This 8-K represents GAAP financial measures that we believe are most directly comparable to those non-GAAP financial measures, and it provides a reconciliation of those measures as well.

I will now turn the call over to Carlos.

Carlos Cardoso

Thank you, Quynh. Good morning everyone. Thank you for joining us today. As we had expected, the microenvironment was more challenging in the first half of fiscal 2010 and showed strong growth during the second half of the year. During this time, we continue to execute our strategy and as a result, Kennametal has been delivering strong operating results. Many of our industrial end markets are benefiting from higher volume. The developing market continues to lead the recovery, with improving conditions in North America, as well as Europe. From a year-over-year perspective, we had organic sales growth of 39% in the June quarter.

In addition, we again experienced sequential revenue growth from the March quarter, the fourth consecutive quarter of sequential growth. Our customers continue to cautiously replenish their inventories. This activity is now overstocking but instead represents customers buying for their near-term needs. In addition, Kennametal will continue to focus on our value sell approach, which has always been a key competitive advantage for our products. Currently, raw material costs are trending relatively flat. However, if those costs increase substantially due to demand growth, then of course this would benefit the overall economic environment and in that case, higher volumes would provide a partial offset to improve manufacturing absorption. In addition, we are confident in our ability to pass through necessary pricing and maintain the margin discipline.

During the quarter, we also continued to execute our strategy to resize the company and lower our fixed costs. We continue to implement our restructuring initiatives and we remain firmly on track to realize 155 million to 160 million of permanent annual savings. Those represent permanent savings and they are increasing in momentum. For fiscal year 2010, our restructuring savings were approximately $137 million. Our adjusted earnings per share of $0.61 for the June quarter reflect sequential improvement of 20% or 56% from the March quarter. The sequential improvement in EPS was driven by higher sales volume, as well as continued strong operating leverage. As demonstrated by the June quarter, we are realizing continuing sales growth, as well as higher incremental margins due to our much lower cost structure.

I'd like to thank our employees for all their hard work. Those accomplishments are driven by the dedication and efforts of our global work force. While the economic climate continues to be somewhat volatile, we also continue to gradually improve and overall macro trends were in the positive territory. During the quarter, US industrial productions continued to grow and manufacturing activities around the world steadily increase. The environment in Euro Zone continues to be uncertain, with some risks from government debt crisis.

That said, I visited a number of customers in Europe during the quarter and saw growing production and sales activities. Within Europe, Kennametal has the most presence in Germany, which is the largest economy in that region and a leading export country. Our company is well positioned to continue to serve our many customers around the world, including meeting demand from emerging markets. In Asia, we continue to see a positive momentum in our trends. I just recently visited the region and growth in that area remains strong, driven by sectors such as small automotive engines, aerospace and rail infrastructure. The outlook for investments in Asia continues to be bright. For instance, Volkswagen plans to build two new plants in China, and there are planned auto ops investments; in Chennai, India by Hyundai, Ford and Mercedes-Benz. Kennametal has continued to experience positive award trends in this region.

From a macro perspective, I would like to discuss our view of certain end markets served. In transportation, quoting activity is increasing and growth is expected to continue, but may moderate somewhat over the next six months. Major manufacturers continue to promote electric and low emissions vehicles with some new entrants into the market, such as [Telsa], Cisco and BYD. Kennametal continues to focus on those opportunities. In addition, Kennametal products bring value to customers by reducing labor content and maximizing machine utilization.

In aerospace, the pace of orders of commercial aircrafts are picking up as the economy rebounds. For example, Airbus and Boeing recently announced at Farnborough Airshow in the UK that they received commitments for 237 plus jetliners valued at approximately $28 billion. We are in agreement with the analysts in this segment that this signals an upturn in the aviation industry. Regarding Kennametal's participation in this sector, we are seeing an increase in requests for quotes, specifically on recent programs that are poised to start production over the next two to three years for prototypes, certification and testing.

In earthworks, coal stockpiles are decreasing, although very slightly around the globe. We are starting to see steady base metal and ore pricing, which will benefit our focus on hard rock mining customers. In highway construction, the season so far has been relatively flat compared to prior years. In addition, we feel that shortfalls in the government budget funding may impact the remainder of calendar year 2010. In energy, the BP oil spill is not expected to have a major impact on Kennametal's business. We continue to identify opportunities related to alternative growth areas such as shale reserves, overseas exploration, and shallow water exploration. As a reminder, Kennametal is a major player on the natural gas part of the equation.

In North America, gas inventory reserves continue to be depleted due to higher energy demand given the favorable cooling requirements from the above normal heat wave hitting most of the region. In addition, power generation will continue to be a growth target for both fossil and emerging technologies. This fits well with our total solution provider and market-facing structure.

Regarding our near-term strategies, we expect to have reduced our manufacturing footprint by a total of 20 facilities, including divestitures, when our restructuring initiatives are completed. At the same time, we have retained our operating capacity by shifting production to existing plants according to our lean practices. Those actions, along with the strong focus of streamlining our business, have enabled us to operate profitably at $2 billion in sales. And in addition, we are scaleable to handle up to $3 billion of sales without significant additional capital investments.

As we move forward into fiscal year 2011, I want to touch on the fact that Kennametal has implemented a new operating structure at the start of our new fiscal year on July 1st, 2010. A key attribute to our new organization is the establishment and reporting of two new operating segments, industrial and infrastructure. The industrial business is focused on customers within transportation, aerospace, defense, and general engineering sectors. The infrastructure business is focused on customers within the energy and earthworks market. Our new structure provides an enhanced market sector approach and a more customer centered focus. In addition, no enterprise provide a better platform for continually improving our efficiencies and effectiveness of our operation. Based on the forecast from global insights for expected industrial production, for IT, rates for fiscal year 2011 our guidance correlates to two times IT for developed economy and three times IT for emerging markets. In addition, we expect fiscal year 2011 results to be consistent with historical season pattern, with approximately 60% of the forecast earnings to be realized in the second half of the fiscal year.

I will now turn the call over to Frank, so he can discuss our fiscal results from the quarter in the great detail. Frank?

Frank Simpkins

Thanks, Carlos. I'll provide some comments on our performance for the June quarter and then I’ll move on to the outlook for whole fiscal year 2011. Some of my comments will exclude special items, so please refer to the reconciliation schedules that we provided, our earnings release to Form 8-K.

To summarize, June quarter was another solid quarter, building on the momentum of the March quarter. We executed well on many fronts and didn’t demonstrated strong earnings leverage in both business units. Sales trend continues its positive momentum and we achieved the 39% organic growth in the June quarter. Earnings per share were $0.61. We had solid preoperating tax flow of $113 million for the full fiscal year. Also during the quarter, we entered into a new five year credit facility which enhances our liquidity and operating flexibility.

Now let me walk you through the key items in the income statement. Sales for the quarter were up 40% at $539 million, this compares to $386 million in the June quarter last year. The increase in sales was driven by 39% organic growth and a 1% favorable impact performance. This represents second consecutive quarter of organic sales growth and the fourth consecutive quarter sequential sales growth.

Most recently asked questions about our current sales results have been around developments in Asia and, in particular, China, as well as in Europe. In Asia, sales trends continue to be positive, despite tougher comparison. You'll recall that Asia was the first geography to experience growth last year. Europe's economy has likewise in the subject been inconsiderable focus. As Carlos mentioned, environment in Europe remains somewhat uncertain, but we are seeing positive signals from Germany where we generate over half of our European sales. Furthermore, we do not have direct exposure to Greece and a relatively smaller portion of our sales come from Spain, Portugal.

Turning to the business group sales performance, MSSG had another solid quarter and its sales increased by 44% from the prior year quarter. This was driven by organic growth of 43% and favorable foreign currency effect of 1%. Regionally MSSG experienced improved trends in all geography and they all had organic growth. On an organic basis, Latin America was up 66%, Asia-Pac increase 65% and India sales increased 64% while North America with an organic sales increase of 42% and Europe with an organic sales increase of 34% compared to the prior year quarter. MSSG sales also increased sequential by 8% in the March quarter. Sales gains were made in all geographic markets and majority of locations experienced double digits sequential growth as industrial production continue to improve in all regions. And this is the fourth consecutive quarter sequential sales growth for MSSG. AMSG also turned in another good quarter and their sales increased 34% from the prior year quarter and that was driven by 33% organic growth and also 1% favorable impact of foreign currency. The organic increase was primarily driven by higher sales in mining and the construction products, as well as increased demand for energy-related and engineered products. Sequentially total sales increased by 11% from the March quarter, driven by better performance in all of AMSG’s end market.

Now, a recap of our operating performance. Our reported gross profit margin was strong at 37%. Well, above the 25.6% reported in the prior year June quarter. Our gross margin also improved 250 basis points, up from 34.5% in March quarter and I would characterize both business units extremely doing well from a leverage standpoint. Strong improvement in our gross profit margins was due to the excellent leverage on sales volumes including increased capacity utilization, the benefits from our restructuring initiative and other cost reduction actions. Furthermore, the fourth quarter margins are impressive, given that the quarter was fully loaded with the return of all temporary cost reductions such as salary restorations, while the prior year quarter included the impact of furloughs.

Our operating expense increased year-over-year by 18.6% or roughly $19 million to 123 million. The increase in operating expense was held at approximately half the top line growth of 40% despite the impact of having furloughs in the prior year. Operating expense as a percent of sales was 22.9% for the quarter, down from both the prior year and prior quarter. Change in operating expense or the increase year-over-year is mainly attributable to higher incentive compensation, higher employment costs due to primarily the impact of the furloughs of the prior year, the respiration of salaries in the current year partly offset by a restructuring benefits and higher spending on professional fees driven by the implementation of certain long-term strategic projects.

Our restructuring programs continue to yield significant benefits with approximately $38 million of benefits achieved in the quarter and $12 million of incremental year-over-year benefits. Charges of $13 million were incurred during the quarter related to restructuring. We remain on track to deliver the permanent cost reductions from our combined program of 155 to 160 million annually. Operating income increased 61 million compared to an operating loss of 25 million in the prior year. Absent restructuring related charges of both periods our operating income was 74 million compared to an operating loss of 3 million in the prior year. Our adjusted operating margin reached 13.8% despite the cost of approximately $20 million for the respiration of salaries and other employment related costs that had been temporarily reduced. Our double-digit margin performance in the second half of the fiscal year was driven by sales growth, increased capacity utilization, continued permanent savings from restructuring programs, and ongoing costs discipline.

In addition we also have very strong adjusted incremental margins both year-over-year at 51% and sequentially at 55%. And I will point out again that we maintained our incremental margins while absorbing the impact of restoring all of our temporary cost actions in the quarter. The margin performance validates our restructuring initiatives are delivering real and permanent cost savings.

Looking at the Business Group performance, MSSG's operating income was 45 million compared to an operating loss of 29 million last year. Absent restructuring related charges for both periods, MSSG's operating income was 57 million compared with an operating loss of 60 million in the prior year quarter. Primary drivers of the increase in operating income were higher sales, better capacity utilization, structuring benefits, continued cost containments. MSSG's operating margin improved sequentially from the March quarter by 580 basis points to 18.1% from 12.3%. AMSG's operating income was 43 million compared to 14 million in the same quarter last year absent restructuring related charges in both periods. AMSG's operating income was 45 million in the current quarter compared to 18 million in the prior year quarter. Operating income improved due to the higher sales, cost savings from restructuring and ongoing costs containment. AMSG again achieved a strong double-digit operating margin of 19.9% in the quarter which was higher than the 10.9% for the same quarter last year.

This quarter's performance was an all time profitability record for AMSG and for the second consecutive quarter, AMSG's operating margin increased sequentially by 150 basis points up from 18.4% in the March quarter. Corporate operating loss for the quarter was 28 million compared to 9 million in the same quarter a year ago. Absent restructuring related charges in both periods, corporates' operating loss was 27 million in the current quarter compared to 6 million last year. The year-over-year change was primarily due to increased incentive compensation, higher professional fees for the implementation of the certain long term strategic projects, higher employment benefit costs related to the temporary cost reductions in the prior year quarter and discretionary 401(k) contributions. Regarding our bottom line performance, reported fiscal 2010 fourth quarter diluted earnings per share were $0.49 a share compared to the prior year quarter diluted loss per share of $0.45. On an adjusted basis, earnings per share were $0.61 compared to the prior year adjusted loss per share of $0.13.

Turning to the balance sheet we continue to place a lot of effort and intention on driving working capital improvements that have made further progress in that regard. For example, we remain focused and diligent on receivable collection. We further reduced our DSO during the quarter by three days to 57 from 60 at the end of the March quarter and by 11 days versus the prior year. Inventory increased only slightly, approximately 2% for the quarter, despite our 9% sequential sales increase. However at the same time I am not satisfied with our accounts payable performance, but we are working on a program to turn this around. Our capital expenditures were $57 million for the full fiscal year as compared to capital spending of $105 million in the prior fiscal year. Capital expenditures net of disposals represented approximately 3% of sales. At June 30, our total debt was 338 million. That's down 148 million from last year. This was driven by the application of proceeds from our equity issuance last July, as well as the strong and improved free operating cash flow. Our debt-to-capital ratio at June 30 was 20.2% compared to 27.7% at June 30, 2009 and our U.S. defined benefits pension plans remain over 100% funded. Cash flow from operating activities for the fiscal year was 165 million and the free operating cash flow for the full year was 113 million.

Another key development for the quarter was the new five year revolving credit facility. The five year tenure extends our debt maturity and enhances our liquidity. We also negotiated favorable fees relative to our prior facility and maintained appropriate cover. We received strong support for the refinancing from the majority of our existing members in the bank group, as well as interest from selected new banks wishing to join the mining growth.

As noted in our press release, I'm going to turn to the outlook now. Our outlook for the fiscal 2011 assumes the global economy and worldwide industrial production will continue to gradually improve and that our overall economic trends will remain in a positive territory. As a result, we expect to experience positive growth during the fiscal year in all geographies, albeit more modest growth in our served European markets. And to help you with your models, the following are some additional assumptions that encompass our outlook. Global industrial production is anticipated to be in mid single digits for the full fiscal year, with higher growth in the first half of the fiscal year. Sales volumes and related capacity utilization are expected to yield strong incremental margins and offset year-over-year cost increases for salary restoration and merit increases, as well as for pension and incentive compensation. Our restructuring programs remain on track to deliver annual on going savings of 155 million to 160 million. And based upon current exchange rates, foreign currency may negatively impact results primarily due to the relationship of the U.S. market.

Seasonal patterns are expected to revert back to historical patterns with approximately 40% of our earnings occurring in the first half and 60% in the second half of the fiscal year. And under these assumed conditions we expect or organic sales growth to be 14% to 17% higher than in fiscal year 2010 and total sales growth to be higher by 11% to14%. This is in line with our goal of growing at least two times the rate of global industrial production. We expect earnings per share for fiscal 2011 to be in the range of a $1.85 to $2.15 per share, excluding charges related to the previously announced restructuring program. We also anticipate cash flow from operating activities of approximately 220 million to 245 million for the full fiscal year. And based on anticipated capital expenditures of $80 million, we expect to generate between 140 million to 165 million of free operating cash flow for the full fiscal year.

At this time I'll turn it back to Carlos for some closing comments.

Carlos Cardoso

Thank you, Frank. As we move forward, Kennametal is positioned to continue benefiting from the economic recovery and meet customers' demands for innovative solutions to improve their productivity. We have the right long-term strategy and the right team of employees in place. The strong operating leverage reflected in the June quarter performance validates our strategy.

As noted previously our fiscal year 2011 guidance correlates to global production activity and reflects strong operating performance. If industrial production activity increases more than is currently forecasted, they'll drive continued strong incremental margins and earnings for Kennametal. We remained discipline in our capital allocation process, while implementing strategies that will enable us to develop new products, increase customer satisfaction, gain market share and grow our top lines. Also, we will maximize our opportunities to realize strong incremental margins and drive earnings growth. We expect to deliver incremental margins of at least 40% on average over the next several years with higher incremental margins earlier in the cycle.

As discussed earlier we implemented a new operating structure effective July 1 in order to take additional advantage of growth opportunities as well as to provide a better platform for continuing to improve the effectiveness of our operations. The new structure provides an enhanced strategy and focus by market segments, which in turn will allow us to grow faster. Sales execution at the regional level, with a more customer focus for sales, for the sales organization and the other markets facing functions such as customer service, marketing, product management, engineering and product performance. The formation of a single global integrated supply chain in logistics organization that unleashes additional opportunities to achieve higher customer satisfaction and realize lower costs to serve more uniform management of administrative functions on a global basis to further improve the consistency, effectiveness and efficiency of the services provided by those functions, the establishment of two new operating segments by market sector, industrial and infrastructure, which replace the previous two operating segments that were based on a product focus.

The industrial business is focused on customers within the transportation, aero space, defense and general engineering market sectors, while the infrastructure business is focused on customers within the energy and earthworks industries. However, more corporate expenses that will be allocated to the new segments than were allocated to the previous segments, the remaining corporate expenses that are determined to be non-allocable will continue to be reported as corporate. So in conclusion, we have a diverse portfolio of served end markets, geographies and businesses mix. We have a strong balance sheet and expect to generate solid cash flow. We have a reputation of bringing technology and innovation to our customers. Our proven ability to operate efficiently in a challenging environment builds our confidence in the believe that Kennametal is a business that is capable of reaching the next milestone of 15% EBIT margin and delivering superior value to our shareholders.

Thank you for your time and your interest in Kennametal. We'll now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from the line of Ann Duignan with JPMorgan.

Ann Duignan - JPMorgan

My first question is on your guidance. I appreciate midpoint $2 and then if I do the 40/60, might imply something close to $0.40 for Q1. Can you tell me if directionally I am correct and why would we anticipate such a drop in earnings sequentially? Are you anticipating a sequential slowdown in revenues?

Frank Simpkins

Ann, I'll start. From an approximation, historically, I think you're in the ballpark from that side. And sequentially, the first half, like I said, the 40-60, we don't anticipate anything unusual, but that's more normal seasonal patterns and it's basically on the number of workdays where we have the European holiday shutdowns. I don't think they'll be as severe as they have in the past. And then I would say in the first half also is last two at this time, we didn't have salary or merit increases and our typical cycle is to start that on October 1, so we have those costs coming back. So that’s nothing unusual but we didn't have it last year given the situation we are in. But from an overall historical pattern and with those additional facts, I think you're in the ballpark.

Ann Duignan - JPMorgan

So we should anticipate a slowdown in operating leverage or incremental profits also. Is that a fair assessment?

Carlos Cardoso

No, it just seasonality.

Ann Duignan - JPMorgan

Seasonality.

Carlos Cardoso

Seasonality, yes.

Ann Duignan - JPMorgan

Just seasonality?

Carlos Cardoso

Operation.

Frank Simpkins

Not at all.

Ann Duignan - JPMorgan

Okay. And then Carlos, perhaps you could talk to us a little bit more about your decision to change the reporting structure. Just a little bit of color. Why now? What drove this decision? I appreciate that you are saying it will result in growth opportunities, but I kind of think of efficiencies and scale and I think product line, I don't think customers. Maybe you could delve deeper into that? Thanks.

Carlos Cardoso

Yes, I think we have been building a foundation over the last two to three years to become more customer focus the work so that we have better connection from the customer at the market all the way to the internal focus [ph]. And we did things like implement as a team in our businesses, so that we can look at some global prospect of look at from our market segments.

And quite honestly, the downturn the economic recession gave us an opportunity as you know to restructure the business, but in order for us to make those permanent costs to stet versus I mean this is one other appreciation between us and other companies.

We have to fundamentally change the structure and changed where we do things become more efficient. So that in the upturn as the economy comes back, we don’t have to add any cost. So its both growth focus as well as away for us to not only keep the permanent cost that we put in place, but to further improve our cost structure like having an integrated supply chain that is focused and driven by one organization.

Ann Duignan - JPMorgan

Carlos, if I am looking at my model, would I appropriately model then a lower SG&A run rate going forward? Is that where we will see the efficiencies?

Carlos Cardoso

You'll see it in the lower SG&A and as well as in our overall margin.

Operator

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

Eli Lustgarten - Longbow Securities

Not too bad. I have got a couple of questions. One technical question for Frank. One tax rate was 28% in the quarter. I'm not sure what it was adjusted. What should be assuming for next year? And, two, you're implying a 3% negative currency. What was the impact of currency was there any currency gain in the quarter from earnings? Looks like about a dime for currency next year. And how much was currency for the year? So probably a pretty big swing year over year that we have to make up?

Frank Simpkins

Yes. Okay. I'll start with the tax rate. Eli, an adjusted basis, it was 26.7%. Essentially what was exactly what we guided to in the fourth quarter? And as we get into fiscal '11, I think I'm going to put a range of 24 to 26, kind of getting that midpoint, right at 25. And just for rule of thumb in your model, if the tax rate moves by 1 percentage point up or down, it's roughly about $0.03 of earnings. But just to give you kind of an idea, so that's kind of on the tax side. From a foreign exchange perspective, yes. When we pull all the currencies, given the bigger exposure we have, it is about a 3% clip. We averaged in fiscal 10, $1.40 euro. Granted it tailed off here towards the end. We probably had a negative $0.03 in the quarter.

And I would say for the year it was probably positive, I don't know, $0.05 to $0.06 most of that occurring in the first half or first three quarters of the year. So not a major swing there. And then to your point, yes, we’ll have a big swing on a year-over-year. So you throw out a dime that's probably a pretty good figure and then you have the swing. So there is a little bit of negative. That's why we try to highlight that fact in our assumptions in the release.

Eli Lustgarten - Longbow Securities

Okay. The volume gains you have are pretty reasonable. You've had outstanding profitability in the fourth quarter and very good in the second half of the year. And now we're going to report the numbers completely differently from now on and it will drive us crazy and all that stuff, but if we were looking at the Company as it exists today, how sustainable are the kind of margins that we saw not only in the fourth quarter, but maybe the second half of the year for both kinds of operations? I mean, that's sort of what you're expecting it to be the average of the half, as opposed to the fourth quarter, which was just seasonally outstanding?

Frank Simpkins

Yes. I mean, again, just like Anne asked, I think we have the normal seasonal pattern coming into play because if you go back and pull our numbers, sometimes we're as low as 35% of earnings in the first half and as high as 40. So I mean, just the number of days. We're not done with the restructuring programs. We're still wrapping up a couple of those facilities. So when we talk about our long-term goal to get to that 15%, we're in the right trajectory. I think the corporate side, we've taken a lot of costs out of there so we’re back to normal, we have some catch-up obviously with some of the incentive comp which would be more level loaded than we had in the past for the first quarter last we have none now we’ll start putting some of that back assuming a normal pattern.

So yes, I mean directionally we should continue to do well. The restructuring benefits, like I said, will kick in. I think we'll see some additional opportunities in some of the international markets and the on going discipline with the new structure, I think it provides you better visibility. So when Anne asked why now? We've been working on; I'll call it the new structure, for over a year. We kind of did a little mini one and advanced materials. We saw how that came out. So this wasn't just a change overnight. This has been a lot of hard work and effort for the whole organization to get ready for the timing we wanted to do it at the beginning of the fiscal year then midstream. We think we're going to get better visibility in interaction looking at both the cost on one hand and working with the customers better on the other.

Eli Lustgarten - Longbow Securities

I understand there were corporate numbers. I'm trying to look at business profitability. When you had an 18% operating margin in metalworking and almost 20% in advanced materials, and even if I look at it from a half standpoint it's more like something like 16% and still like 19%. Are those levels of profitability that we saw in the second half sustainable in 2011? Not for the quarter, but for the full year, should we expect that you would be able to hold the kind of profitability levels that we got to in the second half of 2010? I realize the fourth quarter was phenomenal, but if I average the two, I'm wondering can we hold the levels of profitability that we're currently seeing.

Frank Simpkins

Yes, I mean yes, as you can see by our guidance, our EPS is going to be almost doubled than the EPS of last year. So I mean, that is coming from the profitability of both business, and as we said before, the business are at different profitability levels at the different times of the cycle, we anticipate, when we look at a year average, we anticipate the AMSG to improve slightly and we anticipate as we talk in the previous terms, metal working to improve much better, because they are coming from a much lower base.

Eli Lustgarten - Longbow Securities

One question. You talked a little bit about pricing going on in the market place for your products. We all expect aerospace to become a more important segment of the Company. With all of the production problems they had at Boeing. Will we finally see improvement as a contribution in 2011 from aerospace as a greater percentage of overall activity?

Carlos Cardoso

Yes, I mean. We are excited about what’s happening last, what happen last week in our fund borrow I mean there are people in the aerospace industry. We are very excited about the uptick and the number of orders, pleasantly surprised. So I think as they move and produce this aircraft they have a higher content of composites then we’re going to grow more in the area, as well as in the engines, because the engine production has been sort of depressed as well. So we anticipate to see for that group to be coming back strongly.

Operator

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

Andy Casey - Wells Fargo Securities

Yes. Couple of detailed questions on the quarter and then, just on the quarter, I guess. If you look at the corporate expenses, it had a sequential increase. It has, it did all the way through the fiscal year. And it sets up kind of a gap if you were to retain the operating structure that you had in fiscal 2010, it sets up a bit of a gap in the first quarter. How should we think about, even though you are changing it? And if you didn't change the corporate structure, would that corporate expenses stay at the Q4 levels or go down or go up?

Frank Simpkins

I would say it probably would go back to about the 20 million of quarter range. As we get into the fiscal year we have obviously we have some additional incentive comp that kicked in at the end of the year. And we have some projects we're doing on some of our system. We think that we’re going to tail off in the first half of the fiscal year. So that $80 million kind of number, if we were on a like-to-like basis, is probably about right.

Andy Casey - Wells Fargo Securities

Okay. Thanks. And then on the guidance, going back to all the travels that you have done. Should we expect the normal sequential top line patterns, first quarter next year versus first quarter or fourth quarter this year, because of last year you had some really unusual things going on between the two quarters for some of your customers?

Carlos Cardoso

Andy, I mean, if anything, our first half may be slightly stronger than the 46(b). We may be closer to a 50-50, which is really hard to tell at this point I mean, with everything going on. I'm very pleased to, you know, you go to the customers and our quotations are very, very high, the quotation activity right now. And you go to the customers; they're adding production and so forth. But then you read all of this stuff about what's doing on in Europe and this is double dip.

So it's really hard for us to be to the level of precision that you guys would like us to be. But at this point I would say the 40/60 is the worst case scenario and we're probably going to see a slightly stronger first half than normal seasonality. But what we're saying is we're not reverting back to more of the typical seasonality, because they are less work days, like Frank explained earlier and so forth

Frank Simpkins

And Andy, the only thing I would add is, last year it was kind of once in a 25, 30 year life time where we have sequentially higher sales in the September quarter versus the fourth quarter. Again I don't expect that to happen unless industrial production would all of a sudden really kick in strong. That's kind of how we got to the 40/60.

Carlos Cardoso

I just want to emphasize. I mean, we have a strong correlation between our sales and IP. And IP forecasts are for our current fiscal year are between 6% and 7% and we're growing in the midpoint of 15%, so twice the IP, which is very, very consistent. Now, if industrial production gets better, I mean, we are going to continue to deliver 40% plus incremental margin.

So, at this point we really follow, this is what we see in the marketplace, that’s what’s been forecasted, is the IP between 6 and 7. So we think there our topline forecast is good, based on the data that we have. But to the extent that things get better, we will obviously deliver the equivalent performance to that.

Operator

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

Henry Kirn - UBS

Good. Could you talk about input costs versus price, the delta in the fourth quarter and then what's embedded in guidance?

Frank Simpkins

Yes, Henry, This is Frank. In the fourth quarter is basically flat. Nothing unusual as far as pricing by geographies. I would say very rational across both units. So nothing unusual on that front. And then as we go into fiscal '11, right now, with the big ease for us, between tungsten and cobalt, steel couple of them are up, couple are down. Most recently steel's a little softer, but tungsten and cobalt were a little bit higher. But when we put it together, it’s going to be flattish and if things move, we may get a slight move, but nothing significant on that front

Henry Kirn - UBS

Thanks. And how did European order trends progress as you went through the quarter?

Frank Simpkins

They actually progressed favorably throughout the quarter.

Henry Kirn - UBS

And one final one, if I could. What do you see as the longer term growth rates for the two new segments? And what's embedded in the 2011 guidance?

Frank Simpkins

Well, again, I think on the consolidated that Carlos just talked about industrial production. But I think right now, very similar to what we saw in the fourth quarter. I would imagine the industrial business to grow a little bit faster than the infrastructure business, given the type of customers that we're serving, whether it be transportation.

So I expect the industrial to grow a little bit faster than the infrastructure business, particularly in the first half. Then I would say infrastructure to maybe revert a little stronger toward the end. But for the full year, I would expect industrial to be stronger than the infrastructure business as constructed today.

Henry Kirn - UBS

And longer term is there a difference in the growth rates beyond fiscal 2011?

Carlos Cardoso

Well, I think that once we get into our normal run rate, I would say that then the industrial business will follow closer to the industrial production.

Operator

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

Adam Uhlman - Cleveland Research

Good. Just a question on the balance sheet and the cash flow has been really strong here for some time, and I guess I'm wondering what you are seeing in the acquisition environment right now, in terms of availability of properties and price expectations that are out there?

Carlos Cardoso

We continue to have a strong pipeline, although we’ve been sort of wait and see what the market environment is going to do. And we also think that there is still some realistic expectations relative to the pricing.

So we think that in the next six months to a year we’ll probably see more activity as growth continues to increase. And I think some of the weaker companies starting to feel more pressure on this capital structure, I think that we’re going to be able to get back to some good prices.

Adam Uhlman - Cleveland Research

Are there any geographies that are looking more attractive from an acquisition standpoint at this time?

Carlos Cardoso

Unfortunately in our case, because we are looking for technology, good technology companies, typically those companies seem to be available, more available in developed economies in U.S. and Europe.

What we have done in the past is we have done a very good job of buying companies in developed economies and very, very quickly move their operations into developing economies.

And we have done there with Conforma Clad; we’re doing that now with Tricon and very, very effectively. So we’d probably have to continue along those terms. Although we would like to buy, make some acquisitions in developing economies, is not effect of what we’d like to do as so much of what’s available.

Adam Uhlman - Cleveland Research

Okay. And then earlier you guys mentioned that you were obviously getting better capacity utilization. Where would you kind of, where do you think you are today in terms of utilization rates, and it does look like CapEx is going up this year, what exactly are you spending the incremental dollars on, or where do you think your maintenance CapEx is?

Carlos Cardoso

Yes, I mean, we probably are in the 70s relative to capacity utilization, and Frank will.

Frank Simpkins

Yes, Adam, as far as CapEx goes, yes, it is up, but it is still below our depreciation. Depreciation is about 85 million. So we are still been very disciplined. When I take a step back, I like a strong balance sheet. A year ago, there’s still some scars there, so we go to be very prudent about how we redeploy our capital in case anything would happen on a global perspective that we are well prepared. But as far as the type of investments we are making, we still have some of the systems implementation that we are wrapping up here to help us with productivity.

And then in international markets, where we think we have some significant opportunities to grow the businesses faster, whether its infrastructure or industrial, we think strategically you will see more of that come on the international front than domestic.

Carlos Cardoso

And then, we are in maintenance modes, so you can look at where we spend last year of the maintenance modes. And we also said that we have, we would spend about depreciation until we get to $3 billion. We don’t have to invest in capital equipment to get to the $3 billion goal that we talked about.

Operator

Our next question comes from the line of Chuck Murphy with Sidoti & Company.

Chuck Murphy - Sidoti & Company

Alright. Just a couple of questions on the change in operating segments. I guess first what do you expect the impact to be on operations? I mean how many people are going to be moved around, how much is it going to cost? Is there any execution risk?

Carlos Cardoso

No. I mean, we pretty much have done the realignment. Again, for instance, the majority of the customer facing people do not changed. And we have, as I said being preparing for SAP, when I talked in July 2003 only 60% of our sales came through SAP. Actually less than 60% where today is pretty much in the high 90% to 98% or something like that.

So, we've taking a lot of precautions in minimizing the risk and we feel very good about our ability to just go forward to know within the organization, is much more simplified, and is very global, so I would say that from my perspective that even less risk.

Chuck Murphy - Sidoti & Company

Okay. I guess in terms of the customer facing part of your business, I mean has that kind of not, that has already been implemented for the past few quarters and really just a matter of changing the way you report it to us?

Carlos Cardoso

No. the change of the customer face has pretty much, the way it was there is a little bit of change, but not that much change. I mean that the biggest change is about operating the business from a segment perspective. In other words, we're operating the business from a product perspective. So a guy in the line would be dealing with all these products and was in our enterprise. The guy will see the metal working guy or advanced materials person, okay? Where today he is going to be more market focused and he's going to be more enterprise wise.

And one of the opportunities is in many cases where we very strong in metal working at one customer, we typically were very weak at advanced materials in that customer. So where you end up being is, the person that was metal working person, that was in front of Caterpillar as an example, he is taking on the enterprise, with support of the market segment, because they understand now from a market perspective, not just from a product.

And the market segment guys are supported by the product guys. So the product manager then became more of a back office versus the front office. So it’s basically the same people. They’re just playing a slightly different role in the way we deliver to the customer, the way we listen to the customer is different.

Chuck Murphy - Sidoti & Company

Got you. Kind of make senses. And then my other question was just have you done the calculations to see what industrial and infrastructure sales would have been for fiscal 2010 and this past quarter?

Carlos Cardoso

We have not.

Chuck Murphy - Sidoti & Company

Okay.

Carlos Cardoso

We have not. I mean, as soon as we can put that out, we are going to do that. But we want to make sure that we have high level of confidence. And so at this point we are focused on putting together the FY '11 plan and preparing obviously for a guidance at this point.

Chuck Murphy - Sidoti & Company

Yes. Okay.

Quynh McGuire

Yes, this is Quynh McGuire. To the extent that we can get the restated fiscal '10 numbers in the new segment structure by Analyst Day, we’ll do that, but as a last resort, you’ll certainly get the information every quarter as we compared it to prior year, but our hope that we can get it used in rather than later.

Operator

Our next question comes from the line of Holden Lewis of BB&T.

Holden Lewis - BB&T Capital Markets

I was interested I guess just in exploring the corporate expense a little bit more. Seems to me like you did $100 million in corporate expense costs in 2010, and frankly the first half wasn't necessarily fully loaded with those costs, and so conceivably if they had been fully loaded that $100 million or $98 million would have been somewhat higher, and now you are arguing it is going to be something like $80 million. It seems like a big drop. Maybe some consultants fall out and some things like that, but it seems like a big drop. I want to get a little more color for why sequentially it would fall off so much?

Frank Simpkins

I mean, first of all, there was restructuring charges in there. Remember we book the cover stuff so it had almost had 9 or $10 million just in restructuring. So if you take a backdrop to 90 and I think some of the other that will fall off from compensation and I’ll call it professional fees, get you back down about that 80, coupled with the restructuring benefits kicking a little bit stronger, so I mean the big piece Holden is kind of the restructuring one that you’re missing.

Holden Lewis - BB&T Capital Markets

Okay. Okay. And then can you also comment on I guess a couple of your specific market trends. You sound pretty confident about the China Asia market but I think in your monthly numbers, you have seen China I think uniquely among most other including by markets maybe decline a bit sequentially in the last couple of months. You haven't seen that in other markets. Seems to tie in with the PMI readings coming out of China. What level of confidence do you have that China is not in sort of the early stages of slowing materially, given what you have seen in the monthly data?

Carlos Cardoso

Well, this is the data that we have. I mean actually was there last week and I may with the top sales people, sales management there and visit with some customers. I want to tell you if we were to look just to at the coding activity for no projects, we've probably I don't remember the last time we had that much activities right now as we speak. I mean as of last week number one.

Number two is it's hard in China to first look at month-to-month basis because we have projects that kick-in and projects that’s still a good percentage of our sales there. So we made of that some sales in previous months or two months, three months ago for special big projects that we sold and/or reversed. And I would tell you that what we found for the last few years is that the Chinese government is managing their economy for 8 to 10% GDP. So, when they get closer to 8% they start to accelerating, when they get closer to 10%, they start decelerating. Obviously, they have shown they have ability to do that. So, we have a high level of confidence that China is going to continue to do well.

Holden Lewis - BB&T Capital Markets

Okay. And how about with regards to trends in the coal business? I guess again you had a couple of months where maybe that has been I think we have been talking about maybe things slowing down because of maintenance in the mines. Again, any greater visibility as to whether coal is kind of slowing down here and going to be a while, or whether it is going to be stepping up a bit?

Carlos Cardoso

Yes, I mean I think that’s going to be still continued to be flattish. We don’t see anything exciting one way or the other.

Holden Lewis - BB&T Capital Markets

So if is there more about market dynamics and they are just temporary kind of spending cute?

Carlos Cardoso

Yes.

Holden Lewis - BB&T Capital Markets

Okay. And then the businesses you have that are capital spending oriented, have you seen those begin to accelerate or, still maybe lagging the IP part of your business? How are you viewing the capital spending trends?

Carlos Cardoso

The capital spending is starting to do better. And that would say that they would rank among like maybe the third group relative to the growth like they are in third places as far from highest growth to lowest growth.

Frank Simpkins

We even see with on the other side we are trying to buy capital equipment now we know lead times are being extended on our side as well coming out from another way.

Operator

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

Steve Barger - KeyBanc Capital Markets

Good. I want to go back to a guidance question. As I think about the revenue sensitivity to your plan, if sales do end up trending towards the low end of the range, do you think you still have the flexibility to hit the mid point or higher of your EPS guidance? I guess how flexible are you on costs at these revenue and employment levels?

Frank Simpkins

I think on the low side it would be more challenging than obviously the mid-point. But yes, obviously we would counteract and you would have less in percentage of compensation and some other factors. So it will be close.

Steve Barger - KeyBanc Capital Markets

So the midpoint at least is achievable at the low end of revenue?

Frank Simpkins

I mean, that’s tough, Steve. I won’t go that far, but I said it would, it will be close.

Steve Barger - KeyBanc Capital Markets

Just trying to get an idea for revenue sensitivity for the plan. You have a good cash position right now, good strong free cash flow guidance. If the year does unfold the way you think it is, which is, two times IP growth and we have good overall environment, what is the appropriate debt to cap as you look forward, and is there is price where you would start to look more favorably at share buyback?

Carlos Cardoso

Yes, we always thought under normal conditions, the good environment, economic environment, our debt GAAP should be in the 30s right? Yes, we have a lot of room and certainly we would be looking at our normal uses of cash, things that we’ve done in the past from acquisitions to buybacks to dividends, and so forth.

Steve Barger - KeyBanc Capital Markets

Kind of in that order?

Frank Simpkins

Yes, again, it probably already, if we have the wishlist, it would probably be inorganic first, CapEx, repurchases and then dividends. And we could select one or the other, but I mean, obviously, that’s where I see it.

Operator

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

Joel Tiss of Buckingham Research Group

Hi, guys. Most of them have been answered. Which part of the transportation business are you expecting to slow down a little bit? Can you be a little more specific there?

Carlos Cardoso

Well, it's not so much a slowdown as it is, I mean, they coming along some really good calms, but let me just look at. I think that we're going to continue, I don’t think the acceleration you ask is going to be at the same level going forward than it has been in the last year. And that's primarily one of the bigger drivers.

Joel Tiss of Buckingham Research Group

More auto or truck?

Carlos Cardoso

More auto, yes.

Joel Tiss of Buckingham Research Group

Okay.

Carlos Cardoso

We don't have a lot, our truck exposure is not that high.

Joel Tiss of Buckingham Research Group

Okay. So it's mostly auto.

Carlos Cardoso

Yes, our exposure, yes.

Joel Tiss of Buckingham Research Group

Can you also just outline some of the factors that could get you from mid single digit industrial production growth, and I appreciate you talked a little bit about international as well, but just some of the like business side factors of getting that kind of a growth rate up to the 14% to 17% range, new products, pricing, and those sorts of things? Thank you.

Carlos Cardoso

Yes. I would say that one other characteristic, one other thing that we’ve done well, I believe there are in the down cycle as we continue to develop new product. So IMPS is coming up in the next couple of months here.

We are going to introduce some high technology products and so forth. So one other growth drivers is there is no product above and beyond the normal IPI. And the second one was we've launched this BDF brand that is aimed at the indirect channel. And we've launched that about six months ago, and it is taking traction, is doing a lot better than what we thought it’s going to do and we are very excited about that. And again with IMPS [ph] coming out it’s going be another kick that would help us.

And then, the third piece is that we are focusing again on this market segments with the new structures. So I would say there three major elements there are helping us grow at two to three times in some cases the industrial production and new products there is video [ph] and there is market segment focus.

Joel Tiss of Buckingham Research Group

Okay. And just last one quick, can you talk a very fast about the competitive landscape, you seeing anybody getting more aggressive or people maybe losing their focus a little bit.

Carlos Cardoso

No, I think that they are pretty much on the same boat. Again, in the downturn we continue to see the small players getting eaten, struggling and but as the economy goes up those that survive will continue to give us fit [ph] and the big players are coming out of this downturn strongly.

Operator

There are no further questions at this time. I’ll turn the conference back over to management for any closing remark.

Quynh McGuire

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

Operator

Today’s conference will be available for replay beginning today at 1 o'clock p.m. Eastern Standard Time. It will run through mid-night Eastern Time on August 29, 2010. The number to dial to access the replay is 1800-642-1687 for U.S. callers and 706-645-9291 for international callers. The conference id number to access the replay is 82356133. This concludes today’s conference call. Thank you all for participating and you may now disconnect.

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