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Kennametal Inc. (NYSE:KMT)

F1Q2011 Earnings Call

October 28, 2010 10:00 am ET

Executives

Quynh McGuire - Director of IR

Carlos Cardoso - Chairman, President, and CEO

Frank Simpkins - VP & CFO

Marty Bailey - VP, Finance & Corporate Controller

Analysts

Eli Lustgarten - Longbow Securities

Adam Uhlman - Cleveland Research

Holden Lewis - BB&T

Ingrid Su- JPMorgan

Walt Liptak - Barrington Research

Eric Crawford - UBS

Andy Casey - Wells Fargo

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 First Quarter Fiscal Year 2011 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)

I would now like to turn the conference over to Quynh McGuire, Director of Investor Relations. Ms. McGuire, you may begin the conference.

Quynh McGuire

Thank you, Regina. Welcome everyone. Thank you for joining us to review Kennametal's first quarter fiscal 2011 results. We issued our quarterly earnings press release earlier today. You may access this announcement via our website at www.kennametal.com. Consistent with our 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 November 28, 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 and thank you for joining us today. During the September quarter, we saw continued improvement in the global economy. Our industrial end markets are benefiting from an increase in manufacturing activities. The developing markets continue to show the strongest growths with North America as well as Europe reflecting ongoing activities.

The first quarter of fiscal year 2011 reflected excellent performance by Kennametal at many levels. We realized organic sales growths of 34% compared with prior year quarter. We achieved record operating margin performance for any first or second quarter. Our adjusted earnings per share of $0.47 reflects an improvement of $0.51 per share compared with prior year period.

The year-over-year improvement in EPS was driven by increased sales volume and higher incremental margins. We continue to realize significant year-over-year sales growths as well as strong operating leverage. Restructuring has been an important driver in enabling Kennametal to further streamline our cost structure and we continue to implement those initiatives.

We currently have four plant closures underway and we are on track to realize $165 million of permanent savings on an annualized basis. That is up $5 million from our previous guidance. When those efforts are complete, we have reduced our manufacturing footprint by a total of 20 facilities including divestitures.

At the same time, we will have retained much of our operating capacity as a result of utilizing our lean practices to shift production to our other plants. As we continue to focus on top line growth we retain our value selling approach for the end markets we serve. We have begun notifying our customers of price increases effective on October 1st. And we will continue to implement pricing actions throughout fiscal year 2011, as appropriate.

From a macro perspective, we continue to see growth on a global basis. North America and Europe are positive with emerging markets showing the greatest strength. Currently we generate 52% of sales outside of North America with 26% coming from the rest of the world regions, while we expect that customers will remain cautious, overall demand continues to rise.

We experienced that first hand in early September at the international manufacturing and technology show or IMTS held in Chicago, where we showcased our innovative new products for Kennametal NVIDIA brand. Attendance at the show was good and machine tool builders reported seeing a healthy level of customer demand.

In addition, we generated many new leads from the Kennametal NVIDIA booths combined. Five times the number we believe that we receive in a previous IMTS in 2008. We believe those are encouraging indicators of overall customer sentiment.

In transportation, the growth transcend to be decelerating in the U.S. In Europe, Germany's sales are increasing and demand is being driven primarily by export markets. China and India both continue to see growth in this sector.

In aerospace, order backlogs are growing. The suppliers are maintaining a high focus on low inventories. As commercial revenues passenger miles continue to trend upwards this will benefit long-term cost of market sales.

In energy on a year-over-year basis U.S. rig count increased 62%. Canada rig count grew 24% and international rig count is higher by 16%. In addition, natural gas and storage is 6% above the five-year average, which is a more favorable level than a year ago.

In the earthworks business, gross construction customers still remain conservative due to the uncertainty related to funding for public works projects. On a favorable note, coal stockpiles have continued to decrease which leads to increased volumes in mining activities.

From a raw materials cost perspective we expect that market conditions may be volatile in the near-term, especially related to tungsten prices but because our products provide tremendous value to our customers we are confident that we can maintain margin discipline. As a result, of better visibility across our business as well as our continued confidence in sustaining strong operating leverage, we have significantly increased our guidance for sales growth, earnings per share and cash flow for fiscal year 2011.

We remain committed to further balancing our mix in end markets served, geographic presence and portfolio of business. September quarter results demonstrate that Kennametal global team can effectively execute our strategies. We are a resilient company, as proven by our ability to weather one of the deepest recessions in history and emerge an even better company.

By maximizing opportunities that the down turn provided we improved our cost structure further implemented our channel brand strategy and realigned our organization. We strengthened our foundation, positioned Kennametal to benefit during the economic downturn, upturn in front of us and placed our company in a path to becoming a breakaway company.

I will turn the call over to Frank now so that we can discuss our financial results for the quarter in greater detail. Frank?

Frank Simpkins

Thank you, Carlos. I will provide some comments on our performance for the September quarter and then I will move to our updated outlook for the remainder of fiscal 2011. Some of my comments will exclude special items, so please refer to the reconciliation schedules provided in our earnings release related to Form 8-K.

To start, the September quarter started off the new fiscal year on a very positive note. We had a stronger than expected top line performance. That was across all markets and all geographies. We are also pleased with the exceptional operating performance and leverage delivered by both of our business segments and our operating adjusted margins of 11.7% was a September quarter record and as a result of our performance, we are increasing our annual sales and earnings guidance for fiscal 2011.

As you know, in order to take advantage of growth opportunities as well as provide a better platform for continually improving efficiency and effectiveness of our operations we implemented a new operating structure at the start of new fiscal year on July 1st, 2010. This was highlighted at a recent Analyst Day in New York.

As a reminder, the key attribute of the new structure is the establishment of two operating segments by market sector, which replaces the previous two operating segments that were based on a product focus. The prior two segments were MSSG and AMSG. The two new reportable operating segments are named industrial and infrastructure.

The industrial business is focused on customers within the transportation, aerospace, defense and general engineering market sectors while the infrastructure business is focused on customers with the energy and earthworks industries.

Additionally, more corporate expenses are a now allocated to the segment, so you will see a smaller portion in the corporate line, as the new segments are fully loaded with all related costs.

Now, I will walk you through the key items in the income statement. Sales for the quarter increased 29% to $529 million as compares to $409 million in the September quarter last year, increase in sales was driven by a 34% organic growth partly offset by 3% unfavorable impact on foreign currency effect and 2% unfavorable impact on fewer business days.

This represented the third consecutive quarter of year-over-year organic sales growth. As Carlos mentioned looking at our sales by geographic area, 52% of our sales are generated outside of North America and in the quarter our rest of the world grew to 26% of sales the same as our sales in Western Europe.

Further, compared to last year rest of world grew from 23% to 26% of total sales. Turning to the Business Group sales performance. The industrial segment sales increased by about 33% from the prior year quarter. And that was driven by organic growth of 39% partly offset by unfavorable foreign currency effect of 4% and 2% on favorable impact due to fewer businesses.

On an organic basis sales increased from all served market factors led by growth in general engineering and transportation with increases of 46% and 39% respectively. And from a regional view, sales increased by approximately 40% in Asia, 30% in the Americas, and 22% in Europe.

We did see sales trends revert a bit to normal seasonality but a few markets mainly general engineering did do better sequentially from the June quarter.

Infrastructure segment sales increased 23% from the prior year quarter and that was driven by a 25% organic growth, slightly offset by 1% unfavorable foreign currency effect and 1% impact due to fewer business days. The organic increase was primarily driven by 46% higher sales of energy and related products as well as increased demand for earthworks products and there from a regional view sales increased also 40% in Asia, 22% in the Americas and 13% in Europe.

Now, a recap of our operating performance. Our reported gross profit margin was strong at 35.7%, well, above the 28.8% reported in the prior year September quarter. The improvement in our gross profit margin was the direct result of higher sales and related increased capacity utilization, higher restructuring benefits and ongoing cost discipline. The business levered well in the quarter.

As Carlos mentioned, we did experience slightly higher raw material costs in the quarter that is both year-over-year and sequentially. The main driver is higher costs for tungsten. We have already initiated pricing action to address this issue.

In addition, the prior year quarter benefited from temporary cost measures such as salary cuts and suspension of the 401(k) match. We have previously advised that the total impact from salary reductions was approximately $7 million per quarter and the 401(k) match impact was in addition of $2 million for a total of $9 million.

Turning to operating expense. They increased year-over-year by 7.6% or $9 million to $125 million. Approximately half the year-over-year increase was due to the restoration of the temporary employment cost actions taken in the prior year. The remaining increase is mostly due to higher professional fees for strategic projects.

And our operating expense, as a percent of sales was 23.6% for the quarter, down 480 basis points from the prior year percentage of 28.4. Our operating income increased to $58 million compared to an operating loss of $10 million in the prior year. Absent restructuring and related charges in both periods operating income was $62 million compared with an operating loss of $1 million in the prior year.

We levered well, again this quarter with the strong incremental margin of 52%. Adjusted operating margin reached 11.7 despite the restoration of salary and other related costs that had been temporarily reduced in the prior year quarter.

Looking at the business segment performance. The industrial segment operating income of $36 million compared with an operating loss of $18 million for the same quarter of the prior year. Absent restructuring and related charges in both periods, industrial's operating income of $39 million compared with an operating loss of $11 million from the prior year quarter.

The main drivers of the increase were higher sales volume good capacity utilization and incremental restructuring balance. An industrial adjusted operating margin increased substantially from the prior year quarter to 11.8% from a negative 4.6.

The infrastructure segment operating income was $27 million and that compares with $12 million in the same quarter of the prior year. Absent restructuring and related charges in both periods, infrastructure's top rated income was $28 million in the current quarter compared with $14 million last year.

The operating income improved primarily also due to higher sales volume. Improved capacity utilization and incremental restructuring benefit. Infrastructure's adjusted operating margin increased to 14% from 8.5% in the prior year quarter. And keep in mind that both business segments result in to the much higher portion of corporate operating costs than we have previously.

The corporate operating loss for the quarter was $5 million compared to $3 million in the same quarter last year. The year-over-year change was primarily due to higher professional fees for the upgrade to our new enterprise system. Regarding our overall bottom line performance reported first quarter fiscal 2011 diluted earnings per share of $0.42 compared to the prior year quarter diluted loss per share of $0.12. And adjusting for special item its earnings per share were $0.47 compared to the prior year quarter adjusted loss per share of $0.04.

Turning to the balance sheet. We continue to focus on driving working capital improvements while investing in our business. We remain focused and diligent on receivable collection we further reduce our days there outstanding by one day in the quarter to 56 and by 12 days compared to the prior year.

Inventory increased 9% compared to June 30 and our turns remain at 3.4 turns. The increase in inventory was two fold. We added additional strategic law materials and finished with inventory to support future sales growth.

Our capital expenditures of $10 million were about the same as the capital expending of $9 million in the prior year quarter. Capital expenditures net of disposals represented approximately 2% of sales.

At quarter end, our total debt was $319 million down $49 million from September 30 last year. Our debt-to-cap ratio at September 30 of 18.2% compared to September 30, 2009. Further more our U.S. defined benefit pension plan remains over a 100% funded were also upgraded by Fitch to BBB flat and all rating agencies have a solid investment grade rating.

In consistent with our capital structure of principles in our priority to invest in our business and increase shareholder value our Board of Directors authorize a new share repurchase program of up to 8 million shares of our outstanding common stock.

This will be used primarily to offset dilution from the equity issued under our employee benefits program. This is a multi-year program and as you know we have not had a program in space of September 2008, and this is consistent with our capital structure principal and our priority uses of cash.

Now, let me update everybody on our current outlook. First, we expect economic conditions including global investor production to continue to improve at a gradual rate with the first half of our fiscal year stronger than the second half. As a result of our first quarter performance and slightly better visibility we expect our annual organic sales growth rates to be better than our previous guidance by more than 400 basis points.

Currency will still be a drag year-over-year and given the recent trends and volatility in the currency market, we expect the Euro to average $1.35 versus $1.40, we have realized last year, this is up from our previous guidance of $1.30.

We still anticipate that sales volumes and related capacity utilization as well as further incremental restructuring benefits due to strong incremental margin and more than offset year-over-year cost increases for temporary items such as the salary, restoration, merit, pension, and benefit compensation.

And here are some other factors that we have considered in arriving at our outlook. We are assuming raw material costs have increased and we have initiated price increases to offset those. Construction benefits are running favorable to our plan and we now expect to reach $165 million in annual savings, that's up $5 million from our prior guidance and given the mix of our business, we now anticipate a slightly higher effective tax rate.

And finally, seasonality patterns appear to be in line with historical ranges and it looks like expect approximately 40% of our earnings in the first half and 60% in the second half.

And under this assumed conditions, we expect organic sales growth for the fiscal year to be 19% to 21% and total sales to be 18% to 20%. And this is in line with our goal of growing at least two times the rate of industrial production. We expect our earnings per share, our adjusted earnings per share for fiscal 2011 to be in the range of $2.25 to $2.45 per share excluding the charges for the previously announced restructuring program.

We also anticipate cash flow from operating activities to be approximately $240 million to $260 million for fiscal 2011 based on anticipated capital expenditures of $80 million we expect to generate between $160 million and $180 million or pre-operating cash flow for the full fiscal year.

Now, I would like to turn it back to Carlos for some closing comments.

Carlos Cardoso

Thank you, Frank. Moving ahead, Kennametal is well positioned to benefit from the economic upturn and we are prepared to serve customer demand. We have made the necessary changes to reposition the company and emerge in better condition than ever. We already resized the company and have aggressively lowered the fixed costs.

Kennametal is now scalable up to $3 billion of sales, a goal we can achieve without making any significant additional capital investments. Based on an ongoing improvements in the worldwide industrial production and our ability to maintain strong operating leverage, we have increased our guidance as Frank said for fiscal year 2011 accordingly.

Our revised guidance in the range of $2.25 per share to $2.45 per share compared with previous range of $1.85 to $2.15 per share, represents an increase of 18% in the mid point.

During the current cycle, we expect to achieve higher incremental margins than in the past periods. We believe that we can realize 40% incremental margin over the cycle with higher levels earlier in the cycle.

In the meantime, our strategies remain consistent. We continue to focus on customers in their respective end markets, develop new core products and drive top line growth. Over the long-term, we will continue to balance our served end markets, business mix and geographic presence to improve our exposure to fast growing markets and regions.

In addition, we will maintain a disciplined approach to capital allocation in order to further build shareholder value. We have always been prudent in our uses of cash, which includes reinvesting to add value, making acquisitions, paying dividend, and repurchase shares to offset dilution. In fact, the Board just authorized a share repurchase program of up to 8 million shares, which we will use primarily to offset share dilution from equity issued under the employee benefit programs.

The foundational work to advance our mission has been done. Now, we are transforming Kennametal to a market pacing organization to grow our top line and increase our profitability. We are driving a sharper customer focus and delivering improved productivity.

In summary, we are in excellent position to achieve the next milestone target of 15% EBIT margins and 15% return investment capital for fiscal year 2013 and delivering superior value to our shareholders. Thank you for your time and your interest in Kennametal. We will now take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Eli Lustgarten with Longbow Securities.

Eli Lustgarten - Longbow Securities

Good morning, nice quarter. One second, you said the tax rate will be some what higher. I guess, the adjusted tax rate I think was 25 to 24 quarter if I do it correctly, to that we are talking like 26% or 28% or something like that?

Frank Simpkins

The reported rate, as you know in the release is 27.6%. So, it is about 100 basis point, a little bit less than that, Eli and that is why we guided, I would say 26% to 28%. The only potential there obviously will be the mix of business, and that's all jurisdiction made, but if the Government in the U.S. decides to tax the credit and not going (inaudible) session and we could get a little bit of balance at there, but we can't build that in or becomes a effective litigation.

Eli Lustgarten - Longbow Securities

And, yes, in the guidance you just gave us 40% in the first half, which the implied quarter second quarter is relatively flat with the first quarter, some where between $0.43 and $0.51 I think if we were true to your guidance. Can you give us some idea then how volume for the rest of the year because I know the second quarter gains still be in the low to mid 20s and then you will be trading downward but how you are seeing rest of the year, and more importantly because we have new margin calculation to go through, how do you see the operating profitability averaging for the year, for both the industrial and for structure sector?

Frank Simpkins

I think the margins, you know, if the first up the 46, that is approximation and the best we can give you at this point. But I would imagine the second half, the margins will now be better given the fact that we have more work days, we will have some of incremental restructuring benefits in the second half. So, we feel pretty good about that and then from an incremental margin we will still get 40% for the year. The one thing, I remind everybody is that we don't get 40% leverage on the, benefit of the foreign currency translation benefit. It doesn't fall, so if you exclude that out of the number we will be down and back where we need to be.

Eli Lustgarten - Longbow Securities

I guess, I was trying to driving more the operating margins were 14 in the first quarter, which I know which is effective. What kind of noise margins you think you can do in each of those sectors based on the new segments and putting the corporate numbers up there? What kind of range of profitability should we expect in the sectors?

Frank Simpkins

I think you have to look at the performance that we have had in the past. The first half profitability to your point is similar for the most case and then we will get a little bit of a step up in the second half. Now from the seasonality perspective, infrastructure will have some seasonality in the second quarter, particularly in Europe because of the construction business and that is typically routine. That obviously is stronger in the third, fourth quarter and I would imagine the industrial business will continue to progress on a positive trend for the rest of the fiscal year.

Eli Lustgarten - Longbow Securities

The implication at that, the infrastructure will be second quarter margin will be probably a little lower than the first quarter?

Frank Simpkins

Yeah, that's potentially due to some of the seasonality.

Eli Lustgarten - Longbow Securities

Yeah. And one final question. Can you talk about the impact of restructuring on the rest of quarters? We got a nickel in this quarter, how much is left for the rest of the year

Frank Simpkins

From a restructuring standpoint, as we pointed out, we will have an additional $5 million. So, I would imagine the first quarter, what we is 39 million that would continue to ramp up each consecutive quarter, I would expect another million plus in the second quarter and then maybe a couple million more in the out two quarters going forward.

Eli Lustgarten - Longbow Securities

What about the restructuring charges?

Frank Simpkins

Eli, there will be a little bit, I mean, we are still going hit the 165, I would say. We were anticipating to have a little bit more of those costs in the second quarter but given some of the delays with some of the issues in Europe, some of those costs are left into the third quarter. So, I have Quynh get back to you.

Marty Bailey

I think we have $5 million in the first quarter. Is that the similar in the second, third and fourth? How much more, just trying to get the impact per quarter is all.

Carlos Cardoso

I don't have that with me right here.

Quynh McGuire

Eli, I can follow-up with you on that offline.

Eli Lustgarten - Longbow Securities

Okay. No problem, thank you.

Operator

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

Adam Uhlman - Cleveland Research

Hi, guys, good morning. I was wonder, if you could talk about the increase to the organic revenues to growth outlook for the year, where are you guys feeling better about the business and the full year outlook it seems to counter some of the bigger picture macro indicators that we are seeing a little bit of softness, where are you feeling better about the markets and then about Kennametal's own execution?

Carlos Cardoso

Yeah, Adam, we basically had a very good first quarter above our expectations. And we really did not change much for the rest of the year from the original expectations that we had. So, we dropped all of the benefits we had in the first quarter, increased that for the year. I want to remind everyone and we talked about this in New York if you look at IPI, our plan and our current forecast was based on continually decreased of IPI from our first quarter all the way through the fourth quarter.

And if you look at, from our plan perspective the decreasing IPI from the first quarter to the forecasted fourth quarter it is like a 40% increase in IPI. So, what we are seeing in the marketplace where you have seen so far is consistent with our guidance and forecast. But you know, we saw better results out of Europe than we anticipated, slightly better out of North America and the developing economies continued to be very, very strong.

Adam Uhlman - Cleveland Research

Okay. And then secondly, the raw material outlook comes in costs going up. Could you talk a little bit about that and then, related to that, the rare earth industry is it seems some tight supply out of China is that starting to happen in tungsten now and then is there any concern about supply?

Carlos Cardoso

No, there is no concern about supply. We haven't really seen tightening and I also remind those of you that have followed Kennametal for awhile when the raw materials, when tungsten went up significantly back in 2005 through now we never have seen a, never had an issue with supply. You know, as then the primarily, I would say it price increase, I think there is some manipulation as, you know, in the tungsten because it is there only traded so it is going to be moderate. So, we believe that we can offset any costs of raw material increases with price increases and we are doing just that.

Adam Uhlman - Cleveland Research

Could you help just quantify how much price you need to offset the material cost increases? Is it a big number or a small number?

Carlos Cardoso

I would say that it is probably a relatively small number. At this point.

Adam Uhlman - Cleveland Research

Okay. I'll get back in queue, thanks.

Operator

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

Holden Lewis - BB&T

Thank you, good morning. Trying to get a sense of you have increased you expectations for the restructuring from 155 to 160 up to 165. You kind of increased that number $5 million to $10 million but you still have four plants in the process of being shut and just sort of thinking along the lines of how many dollars you saved per plant, it seems like it is a pretty modest number when you consider how many plants you shut during the downturn and what your original cut of the savings were. It seems like a relatively small number in light of the fourth plant that is still underway. Can you just make some comments on that?

Frank Simpkins

Some of the plants are smaller obviously and then depending on the timing when they officially close, some of those benefits obviously until the next fiscal year.

Holden Lewis - BB&T

Okay. So, continually the number could be higher, just you are not going to get it all during fiscal '11.

Frank Simpkins

Right.

Holden Lewis - BB&T

Okay. And then back to the pricing question really quickly, if I could, I think historically you tried to make it your policy that your first goal is to offset raw material increases with productivity and to the extent you can't do the productivity then you sort of turn to the price increases. Seems like you have been a little bit more aggressive with respect to price increases and you've been getting great productivity gains but sort of going to the price well like something you really can't been doing a bit, have you kind of changed the philosophy a little bit about pricing and if you have what is behind that? Is it greater capability on your part in the market or anything like that?

Carlos Cardoso

Actually, we have had maintained our philosophy is a little different than what you mentioned. Our philosophy is always been that we for the last five years that we want to offset the raw material with increase and we always say that it takes us about 12 months to do that and as we know with our philosophy, our productivity, we want to keep that productivity to be honest with you. So, nothing changed, I mean, I think we are still operating within that philosophy. I think you are correct in your assertion that we have been very, very effective in realizing the price in the marketplace.

And then, I should mention that we have had now seven years of new products, sales from new product to be about 40% of our total sales so that is paying off good dividends because those new products come with higher productivity for the customer. So, you know, getting more of margin out of those products is not as difficult sell. And I think that this year is turning out to be probably one of the most innovative years for us, for Kennametal, so we are putting a lot of new products out there in the marketplace. We haven't slowed down, we didn't slowed down during the recession. Our R&D efforts and I think that we are going to get a good payback from that.

Holden Lewis - BB&T

Great, thank you.

Operator

Your next question comes from the line of Ann Duignan - JPMorgan.

Ingrid Su- JPMorgan

Good morning. It's Ingrid standing in for Ann. If we could go back to the cost savings, I'm assuming that this is a gross number and then somebody's costs, we are going to like we creep back into the system over the years. Where would you expect cost increases over the next few years?

Frank Simpkins

Zero. What about that, we have been very consistent to say the $160 million was fixed costs. We went to a great deal of paying to separate six permanent costs and temporary costs. We said out of $160 million of fixed costs, which is now $165 and $30 million of temporary costs that would come back to the business and those costs are at this point in the run rate all in. This is 20 plants that disappeared. They are no longer here. That cost cannot come back to the business, that cost is gone.

Ingrid Su- JPMorgan

Okay.

Frank Simpkins

Versus the temporary costs that we talked about, which is cutting expenses, you know, not traveling, taking furlough salary, temporary salary cuts, all of those are in. But this, the 20 plants are gone. We are not going to have them any more. That production has moved into current facilities, current square footage that we have that brings the benefits additional benefits because of absorption and things like that.

Ingrid Su- JPMorgan

Okay. So, I mean, volume increases could it is, like other costs but the costs that you have taken out will not come back in?

Carlos Cardoso

The only thing you would have is your typical variable costs associated with higher sales person, that type of stuff.

Frank Simpkins

Raw material, to build those further.

Carlos Cardoso

And just to go back to a prior question. You know, for the charges by quarter, we have $4 million on the first quarter. Probably going to go to about 8 in '013 and then the remaining probably got '011 or '012 in the fourth quarter just to help you guys with the charges by quarter.

Ingrid Su- JPMorgan

Great, thanks. And then, just on the share repurchase program, I just wanted to clarify, this is probably just to offset equity dilution, it is not a signal that you are deemphasizing acquisitions in any way?

Carlos Cardoso

Absolutely not. This is basically 100% to offset dilution.

Ingrid Su- JPMorgan

Have you started repurchasing at all?

Carlos Cardoso

We can now, we have blackouts that we have to follow SEC rules.

Ingrid Su- JPMorgan

Okay.

Frank Simpkins

So, we just got the Board to approve it. So at this point I want to blackout period though.

Ingrid Su- JPMorgan

Thank you very much.

Operator

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

Walt Liptak - Barrington Research

Thanks, good morning, guys. A good quarter. It is good to hear that you are steadfast about the costs not coming back and I wanted to ask about, as business starts to improve could there be costs that come in that are like incremental to R&D or new product or market share and things like that. I think, we would like to see the returns get to that 15%, before doing that I wonder your outlook is for incremental growth related spending?

Carlos Cardoso

I mean I think that we never relative to R&D, as I said we never slowed down our investment in R&D. As a matter of fact, you were at the Chicago IMTS show and you saw the number of new products that we had there, which I would consider massive new product introduction. Nobody in the show had that level of new products out there. And so, I don't see us needing to increase that just because the environment is going to get better.

Frank Simpkins

Well, the only thing I would add, I think with the new structure, I think there is a number of opportunities that we still have on the table and combined of the integrated supply chain logistics and we have better global visibility with all the financial function versus the way it was in the past having individuals. So, you have this great make organization that allow if costs if some deployment would need to invest in our G&A we're able to find it in another to offset as the rate of the offset any grow with the opportunity we have in front of us.

Walt Liptak - Barrington Research

Okay, good. On the guidance, I was a little bit surprised that you took up guidance, I'm glad you did but a little bit surprised. What changed from when you gave your guidance three months ago for the year? Was it that everyone was worried about the sovereign debt and then your first quarter came through without much of a slowdown in Europe? And you mentioned cost outlook, what improved?

Carlos Cardoso

I will let Frank get up there. From my comment, I mean, we experienced a more top line growth than what we anticipated and our restructuring benefits came in at a better than we anticipated.

Frank Simpkins

I think, Walt, too, remember when you are doing your plan, like in June, July of last year, I mean, there were still a lot of costs double dip, a lot of concerns out in the marketplace and it is always try to, very difficult at the June 30 year end to try to predict obviously the new calendar year for fiscal '011 and I think a lot of companies have the similar issues. Going through the guidance and we had expectations that it could happen, we needed a little bit more time. We just did a recent bottoms up forecast and as a result of that forecast a moment we feel much better and hence we pick up the number.

Walt Liptak - Barrington Research

Okay, got it. Alright, thanks very much.

Operator

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

Eric Crawford - UBS

Good morning, Eric Crawford on for Henry. Could you talk a bit about how video performed in the quarter? Is it still 10% of the portfolio and what share of the portfolio is embedded in your guidance for the full year?

Frank Simpkins

You know, it is still 10% of our portfolio. I think that the, we performed better than our expectations and we believe that we will continue to perform better. We introduced the brand at in the U.S. at IMTS at Chicago and to be honest with you, it drove a tremendous level of interest. As a matter of fact, as I said earlier, we had five times more leads, this IMTS than we did in 2008 and actually, I'm just leaving tomorrow morning first thing in the morning to Japan to go to the [Gymsoft] which is the IMTS of the Asia Pacific and we are introducing and launching the Video brand there for Asia. So, it is exciting and s going to continue to grow and we anticipate it is probably going to continue to be 10% of our total sales because we expect the Kennametal business to grow just as much.

Eric Crawford - UBS

Okay. That's helpful. And then, on the M&A front, could we get an update as to what you are seeing there? Are you seeing expectations relative to pricing get more attractive?

Frank Simpkins

Yeah, I mean, we have a healthy pipeline at this point. I think that we continue throughout the recession to talk to potential candidates and to build relationships. I believe the companies that we have an interest in and fall within our guidelines and as you know we have been pretty disciplined about that, still have an expectation of a higher value than what they can get for it now.

So, I don't know when that is going to change but it could change soon but we have a number of companies there we feel are very close from our relationship and knowing what they want and negotiating with them and they continue to see that, you know, they are trying to see what the economic condition is going to do and see if they can, when is the right time for them to sell. So, it is still a little bit of hesitation out there in the marketplace.

Eric Crawford - UBS

Okay. Thanks very much.

Operator

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

Andy Casey - Wells Fargo

Good morning, everybody. Carlos, I jumped on the call a little late, so, I apologize if you addressed this question. But your gross margins suggest fairly high capacity utilization. Is that a part of it in addition to the productivity gains that you talked about and if so does the capacity utilization some what limit the ability to flex the SG&A line?

Carlos Cardoso

Hi, Andy. I wouldn't say it is been a high capacity utilization. I think there is a period that we go through in the first quarter has obviously some seasonality. So, I don't see any issues there.

Frank Simpkins

I mean, as we said if you look at our run rates, we are running at $2.2 billion type of run rate. We can add capacity at this point is $2 billion so.

Andy Casey - Wells Fargo

I'll follow up then later on. Thank you.

Carlos Cardoso

Thanks.

Operator

There are no further questions at this time. I will turn the conference back over to Ms. McGuire for any closing remarks.

Quynh McGuire

This concludes our discussion. Please contact me Quynh McGuire at 724-539-6559 for any follow-up questions. Thank you for joining us today.

Operator

This concludes today's conference call. This call 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 November 28, 2010. The number to dial to access the replay is 800-642-1687 for callers in U.S. and 706-645-9291 for international callers. The conference id number for the replay is 14593557. Thank you for participating in today's conference call and you may now disconnect.

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